Securities registered pursuant to Section 12(g) of the Act:
Common
Stock, no par value per share
(Title of
Class)

Indicate by check mark whether the registrant: (1)
has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]

Indicate by a check mark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
[ ]

Indicate by check mark whether the registrant is an
accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]

The aggregate market value of voting stock held by
non-affiliates of the registrant, as of June 30, 2004, was approximately $228,175,000 (based on the closing price for shares of the registrants
common stock as reported by the Nasdaq National Market for the last trading day prior to that date). Shares of common stock held by each executive
officer, director and holder of 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination for other purposes.

On February 11, 2005, 59,301,375 shares of the
registrants common stock, no par value per share, were outstanding.

DOCUMENTS
INCORPORATED BY REFERENCE

Portions of the registrants definitive Proxy
Statement to be issued in connection with its Annual Meeting of Shareholders to be held in 2005 are incorporated by reference into Part III of this
Form 10-K.

Except as otherwise stated, the information
contained in this Form 10-K is as of February 11, 2005.

TABLE OF CONTENTS
NIC INC.
FORM 10-K ANNUAL REPORT

Page

PART
I

Item
1

Business

1

Item
2

Properties

22

Item
3

Legal Proceedings

22

Item
4

Submission of Matters to a Vote of Security Holders

22

PART
II

Item
5

Market for Registrants Common Equity and Related Shareholder Matters

23

Item
6

Selected Consolidated Financial Data

23

Item
7

Managements Discussion and Analysis of Financial Condition and Results of Operations

24

Item
7A.

Quantitative and Qualitative Disclosures About Market Risk

41

Item
8

Consolidated Financial Statements and Supplementary Data

42

Item
9

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

75

Item
9A.

Controls and Procedures

75

Item
9B.

Other Information

75

PART
III

Item
10

Directors and Executive Officers of the Registrant

76

Item
11

Executive Compensation

76

Item
12

Security Ownership of Certain Beneficial Owners and Management

76

Item
13

Certain Relationships and Related Transactions

76

Item
14

Principal Accountant Fees and Services

76

PART
IV

Item
15

Exhibits, Financial Statement Schedules, and Reports on Form 8-K

77

PART I

CAUTIONS ABOUT FORWARD LOOKING STATEMENTS

Safe Harbor statement under the Private
Securities Litigation Reform Act of 1995: Statements in this Annual Report on Form 10-K regarding NIC and its business, which are not historical facts,
are forward-looking statements that involve risks and uncertainties. Certain matters discussed in this report may constitute
forward-looking statements within the meaning of the federal securities laws that inherently include certain risks and uncertainties. For example,
statements like we expect, we believe, we plan, we intend or we anticipate are
forward-looking statements. Investors should be aware that our actual operating results and financial performance may differ materially from our
expressed expectations because of risks and uncertainties about the future including risks related to economic and competitive conditions. In addition,
we will not necessarily update the information in this Annual Report on Form 10-K if any forward-looking statement later turns out to be inaccurate.
Management continuously updates and revises these estimates and assumptions based on actual conditions experienced. However, it is not practicable to
publish all revisions and, as a result, no one should assume that results projected in or contemplated by the forward-looking statements will continue
to be accurate in the future. Details about risks affecting various aspects of our business are included throughout this Form 10-K. Investors should
read all of these risks carefully, and should pay particular attention to risks affecting the following areas: competition issues discussed on page 11;
government regulation discussed on page 12; intellectual property and proprietary rights discussed on page 12; specific risk factors discussed on pages
13 to 22; and commitments and contingencies described in Notes 2, 4, 7, 8 and 10 to the consolidated financial statements included in this Form 10-K.
Other factors not presently identified may also cause actual results to differ.

AVAILABLE INFORMATION

Our Web site address is
www.nicusa.com
.
Through this Web site, we make available, free of charge, on the Investor Relations section of our Web site
(http://www.nicusa.com/html/info/investor/edgar.php)
our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form
8-K, and all amendments to those reports, as soon as reasonably practicable after these reports are electronically filed with or furnished to the
Securities and Exchange Commission (the SEC). We also make available through our Web site other reports filed with the SEC under the
Exchange Act, including our proxy statements and reports filed by officers and directors under Section 16(a) of that Act. We do not intend for
information contained in our Web site to be part of this Annual Report on Form 10-K.

FREQUENTLY USED TERMS

In this Annual Report on Form 10-K, we use the terms
NIC, the Company, our, and us to refer to NIC and its subsidiaries. All references to years, unless
otherwise noted, refer to our fiscal year, which ends on December 31. We use the term eGovernment to refer to electronic government, and we
use the term portal to refer to an official government Web site outsourced to NIC. We also use the term partner to refer to our
government clients, with which we have contractual relationships for eGovernment services.

ITEM 1. BUSINESS

Business Overview

NIC is a provider of eGovernment services that helps
governments use the Internet to reduce costs and provide a higher level of service to businesses and citizens. We accomplish this currently through two
divisions: our portal outsourcing businesses and our software & services businesses. In our primary portal outsourcing business, we enter into
long-term contracts with governments to design, build and operate Web-based portals on their behalf. These portals consist of Web sites and
applications we have built that allow businesses and citizens to access government information online and complete transactions, including applying for
a permit, retrieving drivers license records or filing a government-mandated form or report. Our self-funding business model allows us to reduce
our

1

government partners financial and
technology risks and generate revenues by sharing in the fees we collect from eGovernment transactions. Our government partners benefit through gaining
a centralized, customer-focused presence on the Internet, while businesses and citizens receive a faster, more convenient and more cost-effective means
to interact with governments.

Currently, we have contracts to provide portal
outsourcing services under our self-funding business model to sixteen states. We typically enter into three- to five-year contracts with our government
partners and manage operations for each contractual relationship through separate local subsidiaries that operate as decentralized businesses with a
high degree of autonomy. We intend to increase our revenues by signing long-term portal contracts with new government partners and by delivering new
services to a growing number of government entities within our existing contractual relationships.

Our software & services businesses currently
include our corporate filings, ethics & elections, transportation and AOL businesses. During 2002, we exited our eProcurement business, NIC
Commerce, and decided to wind down our transportation business, IDT, as part of a broad strategic refocusing of the Company on our profitable core
outsourced portal business. Our corporate filings business, NIC Conquest, is a provider of software applications and services for electronic filings
and document management solutions for governments. Our corporate filings business focuses on Secretaries of State, whose offices are state
governments principal agencies for corporate filings. Our ethics & elections business, NIC Technologies, designs and develops online campaign
expenditure and ethics compliance systems for federal and state government agencies. Also included in our software & services segment is our AOL
division, which serviced an agreement with America Online, Inc. to deliver government information, services and applications through AOLs
Government Guide service. The Companys agreement with AOL expired on December 31, 2004, and was not renewed.

We expanded rapidly following our initial public
offering in July of 1999 and incurred substantial net losses through mid-2002 primarily as a result of our software & services businesses.
Throughout this time period, our core outsourced portal operations have grown and have been profitable. As part of a broad strategic refocusing of the
Company on our outsourced portal business, we became profitable in the second half of 2002 and have been profitable since that time. We expect the
Company to continue to be profitable and have focused the business on operations we believe have demonstrable ability to produce positive net income
and sustainable cash flow in the future.

The Company

NIC Inc. (formerly National Information Consortium,
Inc.) was formed on December 18, 1997, for the sole purpose of affecting an exchange of common stock, in a transaction referred to as the Exchange
Offer, to combine under common ownership five separate affiliated entities under which we conducted our business operations. The five companies were
NICUSA (formerly National Information Consortium USA), Kansas Information Consortium, Indiana Interactive, Nebraska Interactive and Arkansas
Information Consortium. The Exchange Offer was consummated on March 31, 1998, and was accounted for as a business combination. NICUSA is the entity
whose shareholders received the largest portion of the Companys common stock shares and was treated as the accounting acquirer with the purchase
method of accounting being applied to the four other companies. On July 20, 1999, we completed our initial public offering, selling an aggregate of 10
million new shares of common stock for net proceeds of approximately $109.4 million after deducting underwriting discounts, commissions and
expenses.

Segment Information

Our two reportable segments consist of our portal
outsourcing segment and software & services segment. The portal outsourcing segment includes our subsidiaries that operate outsourced government
portals and the corporate divisions that support portal operations. The software & services segment includes our corporate filings, ethics &
elections, transportation and AOL businesses. Although we decided to wind down our transportation business in 2002, it did not yet qualify as a
discontinued operation at December 31, 2004. For additional information relating to our reportable segments, refer to Note 13 in the Notes to
Consolidated Financial Statements included in this Form 10-K.

2

Industry Background

The market for government-to-business and government-to-citizen
transactions

Government regulation of commercial and consumer
activities requires billions of transactions and exchanges of large volumes of information between government agencies and the businesses and citizens
they regulate. These transactions and exchanges include drivers license record retrieval, motor vehicle registrations, tax returns, permit
applications and requests for government-gathered information. Government agencies typically defray the cost of processing these transactions and of
storing, retrieving and distributing information through a combination of general tax revenues, service fees and charges for direct access to public
records.

The limits of traditional government transaction methods

Traditionally, government agencies have transacted,
and in many cases continue to transact, with businesses and citizens using processes that are inconvenient and labor-intensive, require extensive
paperwork and use large amounts of scarce staff resources. Transactions and information requests are often made in person or by mail and are processed
manually, increasing the potential for errors and the need for numerous revisions and follow-ups. Even newer methods, including telephone response
systems, tape exchanges and dial-up computer networks, rely on multiple systems and potentially incompatible data formats, and require significant
expertise and expenditures to introduce and maintain. As a result, businesses and citizens often have no choice but to face costly delays to complete
essential tasks. These delays include waiting in line at a government agency, waiting for answers by telephone or waiting for responses by mail.
Businesses and citizens encounter further inconvenience and delay because they usually can work with government agencies only during normal business
hours. Even when electronic alternatives are available, they often require a cumbersome process of multiple contacts with different government
agencies. Increases in the level of economic activity and in the population have exacerbated these problems and increased the demand for new
services.

Growth of the Internet, electronic commerce and eGovernment

The Internet is a global medium that enables
millions of people worldwide to share information, communicate and conduct business electronically. According to the Computer Industry Almanac, more
than 934 million people worldwide had access to the Internet in 2004, up 32% over 2003. Continued growth is expected to be driven by the large and
growing number of personal computers installed in homes and offices and the decreasing cost of computer equipment. By 2010, Forrester Research
estimates that 1.2 billion homes worldwide will have personal computers. Easier, faster and cheaper access to the Internet, the proliferation of
Internet content and the increasing familiarity with and acceptance of the Internet by governments, businesses and consumers will also continue to
encourage the expanded use of online services. In particular, the growth of high-speed access is accelerating Internet use globally. Market research
firm Point Topic estimates that 123 million homes around the world now have broadband connections.

In the United States, market research firm
International Data Corporation reported that personal computer sales rose to 58.3 million units in 2004, up 10% over 2003. Nielsen/NetRatings estimates
that 139 million Americans considered themselves active Internet users in 2004, and more than 185 million residents had regular access to
the Internet. According to a December 2003 study by the Pew Internet & American Life Project, 87% of U.S. Internet users have computer access at
home, while 48% have Internet access at work. The same study estimates that 66 million Americans were online in a typical day in August 2003, a 27%
increase over the same period in 2000. Nielsen/NetRatings also estimates that 55% of U.S. at-home users accessed the Internet from a broadband
connection, and that figure is expected to rise to 65% by 2007.

The volume of electronic commerce has grown in
parallel with the Internet itself. According to ComScore Networks, the total value of goods and services transacted online in the United States
surpassed $117 billion in 2004.

3

Similar growth trends are seen for eGovernment.
Research firm Input predicts that spending on state and local government information technology initiatives will exceed $49 billion in 2005 and will
grow to $64 billion by 2009. In a May 2004 survey, the Pew Internet and American Life Project found that 75% of all Internet users had sought
information directly from a local, state or federal government Web site during the last three months.

Emergence of the Internet as a medium for eGovernment

The growing acceptance of the Internet and
electronic commerce presents a significant opportunity for the development of eGovernment, in which government agencies conduct transactions and
distribute information over the Internet. By using the Internet, government agencies can increase the volume and efficiency of interactions with
constituents without increasing expenditures or demands on current personnel. In addition, regardless of physical distance, businesses and citizens can
obtain government information quickly and easily over the Internet. For example, motor vehicle administrators can provide instantaneous responses to
auto insurers requests for driving record data by allowing controlled access to government databases through the Internet. This online
interaction reduces costs for both government and users and decreases response times compared to providing the same data by mail or special purpose
dial-up computer connections.

Challenges to the implementation of eGovernment services

Despite the potential benefits of eGovernment,
barriers to creating successful Internet-based services occasionally preclude governments from implementing them. Some of these barriers are similar to
those the private sector encounters, including:



the high cost of implementing and maintaining Internet
technology in a budget-constrained environment;



the financial, operational and technology risks of moving from
older, established technologies to rapidly evolving Internet technologies;



the need to quickly assess the requirements of potential
customers and cost-effectively design and implement eGovernment services that are tailored to meet these requirements; and



the intense competition for qualified technical
personnel.

Governments also face some unique challenges that
exacerbate the difficulty of advancing to Internet-based services, including:



lengthy and potentially politically charged appropriations
processes that make it difficult for governments to acquire resources and to develop Internet services quickly;



a diverse and substantially autonomous group of government
agencies that have adopted varying and fragmented approaches to providing information and transactions over the Internet;



a lack of a marketing function to ensure that services are
designed to meet the needs of businesses and citizens and that they are aware of their availability; and



security and privacy concerns that are amplified by the
confidential nature of the information and transactions available from and conducted with governments and the view that government information is part
of the public trust.

We believe traditional private sector services
generally do not address the unique needs of eGovernment. Most service providers do not fully understand and are not well-equipped to deal with the
unique political, regulatory and security structures of governments. These providers, including large systems integrators, typically take a
time-and-materials, project-based pricing approach that may not adequately balance the responsiveness to change of a successful Internet business with
the longer time horizons and extended commitment periods of government projects.

4

What We Provide to Governments

In our core portal outsourcing segment, we provide
Internet-based eGovernment services that meet the needs of governments, businesses and citizens. The key elements of our service delivery
are:

Customer-focused, one-stop government portal

Using our marketing and technical expertise and our
government experience, we develop, build and operate portals for our government partners that are designed to meet their needs as well as those of the
businesses and citizens they serve. Our portals are designed to create a single point of presence on the Internet that allows businesses and citizens
to reach the Web site of every government agency in a specific jurisdiction from one online location. We employ a common look and feel in the Web sites
of all government agencies associated with our government portals and make them useful, appealing and easy to use. In addition to developing and
managing the government portal, we develop applications that, in one location on the Internet, allow businesses and citizens to complete processes that
have traditionally required separate offline interaction with several different government agencies. These applications also permit businesses and
citizens to conduct transactions with government agencies and to obtain information 24 hours per day and seven days per week. We also help our
government partners to generate awareness and educate businesses and citizens about the availability and potential benefits of eGovernment
services.

Compelling and flexible financial models for governments

With our self-funding business model, we allow
governments to implement comprehensive eGovernment services at minimal cost and risk. We take on the responsibility and cost of designing, building and
operating government portals and applications, with minimal use of government resources. We employ our technological resources and accumulated
expertise to help governments avoid the risks of selecting and investing in new and often untested technologies. We implement our services rapidly,
efficiently and accurately, using our well-tested and reliable infrastructure and processes. Once we establish a portal and the associated
applications, we manage transaction flows, data exchange and payment processing, and we fund ongoing costs from the fees received from portal users,
who access information and conduct transactions through the portal. We are also able to provide specific fee-based application development and portal
outsourcing solutions to governments who do not wish to pursue a self-funding portal solution.

Focused relationship with governments

We form relationships with governments by developing
an in-depth understanding of their interests and then aligning our interests with theirs. By tying our revenues to the development of successful
services and applications, we work to assure government agencies and constituents that we are focused on their needs. Moreover, we have pioneered and
encourage our partners to adopt a model for eGovernment policymaking that involves the formation of oversight boards to bring together interested
government agencies, business and consumer groups and other vested interest constituencies in a single forum. We work within this forum to maintain
constant contact with government agencies and constituents and strive to ensure their participation in the development of eGovernment services. We
attempt to understand and facilitate the resolution of potential political disputes among these participants to maximize the benefits of our services.
We also design our services to observe relevant privacy and security regulations, so that they meet the same high standards of integrity,
confidentiality and public service as government agencies would observe in their own actions.

5

Government Contracts

Our portal outsourcing businesses

Through our portal outsourcing businesses, we
currently have contracts with 23 state and local government agencies. At December 31, 2004, we provided outsourced government portal services through
the following portals:

Government Entity

Year
Services
Commenced

Web Address

Kentucky

2003

www.Kentucky.gov

Alabama

2002

www.Alabama.gov

Vermont

2002

www.Vermont.gov

New
Hampshire

2002

www.NHlicenses.com
www.NHfishandgame.com

Des Moines,
Iowa

2002

www.DMgov.com

Iowa State
County Treasurers Association

2002

www.IowaTreasurers.org

Rhode
Island

2001

www.RI.gov

City of
Tampa

2001

www.TampaGov.net

Kent County,
Michigan

2001

www.accessKent.com

Oklahoma

2001

www.OK.gov

Montana

2001

www.DiscoveringMontana.com

Tennessee

2000

www.Tennessee.gov

Hawaii

2000

www.Hawaii.gov

Idaho

2000

www.accessIdaho.org

Utah

1999

www.Utah.gov

Maine

1999

www.Maine.gov

Arkansas

1997

www.Arkansas.gov

Indianapolis and
Marion County, Indiana

1997

www.CivicNet.net

Iowa

1997

www.Iowa.gov

Virginia

1997

www.Virginia.gov

Indiana

1995

www.IN.gov

Nebraska

1995

www.Nebraska.gov

Kansas

1992

www.accessKansas.org

Our government portals operate
under separate contracts that generally have an initial term of three to five years. Under a typical self-funding contract, a government agrees
that:



we have the right to develop a comprehensive Internet portal
owned by that government to deliver eGovernment services;



the portal we establish is the primary electronic and Internet
interface between the government and its citizens;



it advocates the use of the portal for all commercially valuable
applications in order to support the operation and expansion of the portal;



it sponsors access to agencies for the purpose of entering into
agreements with these agencies to develop applications for their data and transactions and to link their Web pages to the portal; and



it establishes a policy-making and fee approval board, which
typically includes agency members, business customers and others, to establish prices for services and to set other policies.

assume the investment risk of building and operating that
governments portal and applications without the direct use of tax dollars;



bear the risk of collecting transaction fees; and



have an independent audit conducted upon that governments
request.

Currently, under our contracts with the states of
New Hampshire and Vermont, we provide consulting, development and management services for these government portals predominantly under a time and
materials model.

We typically own all the software we develop under
our government portal contracts. After completion of the initial contract term, our government partners typically receive a perpetual, royalty-free
license to use the software only in their own portals.

We also enter into separate agreements with various
agencies and divisions of our government partners for the sale of electronic access to public records and to conduct other transactions. These
agreements preliminarily establish the pricing of the electronic transactions and data access services we provide and the amounts we must remit to the
agency. These terms are then submitted to the policy-making and fee approval board for approval.

Our software & services businesses

Corporate filings

Our corporate filings business, NIC Conquest,
focuses on secretaries of state, whose offices are state governments principal agencies for corporate filings. We have installed Uniform
Commercial Code (UCC) and/or business entity software applications for Web-enabling the back-office systems and processes for
business-to-government filings with the following states: Arkansas, Indiana, Montana, Oklahoma, South Dakota and Texas. We are currently in the process
of installing a similar system for the California Secretary of State. In September 2001, we were awarded a five-year contract by the California
Secretary of State to develop and implement a comprehensive information management and filing system. The contract with the California Secretary of
State is valued at approximately $25 million and is the largest government contract we have ever been awarded. This award is both the nations
largest state eGovernment filing initiative on record and the most comprehensive secretary of state filing system project in the United States. The
Web-enabled document management and filing system will increase efficiency and reduce expenses for California by eliminating paperwork and decreasing
processing and turnaround times. Upon completion, the new system will allow agency customers, primarily from the banking and legal communities, to
search, retrieve, and submit documents online. Customers will also be able to pay fees for a variety of transactions, including new incorporation
document filings, trademark registrations, and UCC filings. The contract includes comprehensive back office document and revenue management systems,
Web and Internet applications that will take approximately 90% of the agencys Business Programs Divisions services online, and imaging and
indexing of more than ten million historical document pages. As part of the contract, we also will provide three years of onsite support and
maintenance for the system.

Ethics & elections

Our ethics & elections business, NIC
Technologies, designs and develops online campaign expenditure and ethics compliance systems for federal and state government agencies. Our current
government clients include the Federal Election Commission (www.FEC.gov) and the state of Michigan. We have also installed filing systems in several
other governments including Arkansas, California, Hawaii, Illinois, Louisiana, Oklahoma, Texas and British Columbia.

7

Our Portal Service Offerings

We work with our government partners to develop,
manage and enhance a comprehensive, Internet-based portal to deliver eGovernment services to their constituents. Our portals are designed to provide
user-friendly and convenient access to in-demand government information and services and include numerous fee-based transaction services and
applications that we have developed. These fee-based services and applications allow businesses and citizens to access constantly changing government
information and to file necessary government documents. The types of services and the fees charged vary in each portal installation according to the
unique preferences of that jurisdiction. In an effort to reduce the frustration businesses and citizens often encounter when dealing with multiple
government agencies, we handle cross-agency communications whenever feasible and shield businesses and citizens from the complexity of older,
mainframe-based systems that agencies commonly use, creating an intuitive and efficient interaction with governments. Some of the online services we
currently offer in different jurisdictions include:

Product or Service

Description

Primary Users

Drivers
License Records Retrieval

For
those legally authorized businesses, this service offers controlled instant look-up of driving records. Includes commercial licenses.

Allows the user to monitor state legislative activity. Users can tag bills by key word or bill number, and BillWatch will send an e-mail when
a change occurs in the status of the bill. Legislative activity can be monitored via wireless access.

Attorneys, lobbyists

Health
Professional License Services

Allows users to search databases on several health professions to verify license status.

Hospitals, clinics, health insurers, citizens

Secretary of
State Searches

Allows users to access filings of corporations, partnerships and other entities, including charter documents.

Permits citizens to renew their drivers license on line using a credit card.

Citizens

Limited Criminal
History Searches

For
those legally authorized, provides users with the ability to obtain a limited criminal history report on a specified individual.

Schools, governments, human resource professionals, nonprofits working with children or handicapped adults

Income and
Property Tax Payments

Allows users to file and pay for a variety of state and local income and property taxes.

Businesses and citizens

Hunting and
Fishing Licenses

Permits citizens to obtain and pay for outdoor recreation licenses over the Internet.

Citizens

Business
Registrations and Renewals

Allows business owners to search for and reserve a business name, submit and pay for the business registration, and renew the business
registration on an
annual basis.

Businesses

In addition to these services, we also provide
customer service and support. Our customer service representatives serve as a liaison between our government partners and businesses and citizens. In
the majority of the portals we operate, customer service representatives are available 24 hours a day, seven days a week.

Revenues

We currently derive revenue from three main
sources:



transaction-based fees;



fees for managing eGovernment operations; and



fees for application development.

In most of our outsourced portal businesses, our
revenues are generated from transactions, which generally include the collection of transaction-based and subscription fees from users. The highest
volume, most commercially valuable service we offer is access to motor vehicle records through our insurance industry records exchange network. This
service accounted for approximately 64% of our portal revenues in 2002, 62% in 2003 and 63% in 2004. ChoicePoint, which resells these records to the
auto insurance industry, accounted for approximately 48% of portal revenues in 2002, 47% in 2003 and 46% in 2004. In 2004, transaction-based revenues
accounted for approximately 81% of our consolidated revenues.

In our other operations, revenues are derived
primarily from fees for managing eGovernment operations and fees for application development and hosting. In 2004, these revenues accounted for
approximately 19% of our consolidated revenues.

9

Sales and Marketing

We have two primary sales and marketing
goals:



to develop new sources of revenue through new government
relationships; and



to retain and grow our revenue streams from existing government
relationships.

We have well-established sales and marketing
processes for achieving these goals, which are managed by our national sales division and a marketing department within most of our outsourced portal
businesses.

Developing new sources of revenue

We focus our new government sales and marketing
efforts on increasing the number of governments and government agencies that are receptive to a public/private model for delivering information and/or
completing transactions over the Internet. We meet regularly with interested government officials to educate them on the public/private model and its
potential advantages for their jurisdictions. Members of our management team are also regular speakers at conferences devoted to the application of
Internet technologies to facilitate the relationship between governments and their citizens. In states where we believe interest is significant, we
seek to develop supportive, educational relationships with professional and business organizations that may benefit from the government service
improvements our service delivery can produce. We also focus our marketing efforts on key government decision makers through the use of print media and
corporate communications.

Once a government decides to implement a
public/private model for managing Internet access to information resources and transactions, it typically starts a selection process that operates
under special rules that apply to government purchasing. These rules typically require open bidding by possible service providers against a list of
requirements established by the government under existing procedures or procedures specifically created for the Internet provider selection process. We
respond to requests for bids with a proposal that outlines in detail our philosophy and plans for implementing our business model. Once our proposal is
selected, we enter into negotiations for a contract.

expanding the number of government agencies that provide
services or information on the government portal;



identifying new information and transactions that can be
usefully and cost-effectively delivered over the Internet;



working with the governance authorities in our existing markets
to ensure that online services are priced in a manner to encourage usage; and



increasing the number of potential users who do business with
governments over the Internet.

Although each governments unique political and
economic environment drives different marketing and development priorities, we have found many of our core applications to be relevant across multiple
jurisdictions. Each of our outsourced portal businesses has a director of marketing and additional marketing staff that regularly meet with government,
business and consumer representatives to discuss potential new services. We also promote the use of existing services to existing and new customers
through speaking engagements and targeted advertising to organizations for professionals, including lawyers, bankers and insurance agents that have a
need for regular interaction with government. We identify services that have been developed and implemented successfully for one government and
replicate them in other jurisdictions.

10

Strategic Acquisitions and Alliances

Since going public in July 1999, we acquired four
companies that comprised the majority of our software & services segment. In 2002, we exited certain of these businesses and completed the
restructuring of the others as part of a broad strategic refocusing of the Company on our profitable core outsourced portal business. For additional
information on our acquisitions, investments and strategic alliances, refer to Managements Discussion and Analysis of Financial Condition and
Results of Operations and the Notes to Consolidated Financial Statements included in this Form 10-K.

Technology and Operations

Over the past 12 years, we have made substantial
investments in the development of Internet-based applications and operations specifically designed to allow businesses and citizens to transact with
and receive information from governments. The scope of our technological expertise includes network engineering as it applies to the interconnection of
government systems to the Internet, Internet security, Web-to-legacy system integration, Web-to-mainframe integration, database design, Web site
administration and Web page development. Within this scope, we have developed and implemented a comprehensive Internet portal framework for
governments, and a broad array of stand-alone services using a combination of our own proprietary technologies and commercially available, licensed
technologies. We believe that our technological expertise, coupled with our in-depth understanding of governmental processes and systems, has made us
adept at rapidly creating tailored portal services that keep our partners on the forefront of eGovernment.

Each of our government partners has unique
priorities and needs in the development of its eGovernment services. More than half of our employees work in the Internet services and application
development and technology operations areas, and most are focused on a single government partners application needs. Our employees develop an
understanding of a specific governments application priorities, technical profiles and information technology personnel and management. At the
same time, all of our development directors are trained by experienced technical staff from our other operations on our standard technical framework,
and there is frequent communication and cooperation, which ensures that our government partners can make use of the most advanced eGovernment services
we have developed throughout our organization.

Most of our portals and applications are physically
hosted in each jurisdiction in which we operate on servers that we own or lease. We also provide links to sites that are maintained by government
agencies or organizations that we do not manage. Our businesses provide uninterrupted online service 24 hours per day and seven days a week, and our
operations maintain fault-tolerant, redundant systems, with thorough backup and security and disaster recovery procedures.

History has proven that our systems and applications
are scalable and can easily be replicated from one government entity to another. We focus on sustaining low-overhead operations, with all major
investments driven by the objective of deploying the highest value-added technology and applications to each operation.

Finally, we have designed our government portals and
applications to be compatible with virtually any existing system and to be rapidly deployable. To enable speed and efficiency of deployment, we license
commercially available technology whenever possible and focus on the integration and customization of these off-the-shelf hardware and software
components when necessary. We expect that commercially licensed technology will continue to be available at reasonable costs.

Competition

We believe that the principal factors upon which our
businesses compete are:



the unique understanding of government needs;



the quality and fit of eGovernment services;

11



the speed and responsiveness to the needs of businesses and
citizens; and



cost-effectiveness.

We believe we compete favorably with respect to the
above-listed factors. In most cases, the principal substitute for our services is a government-designed and managed service that integrates other
vendors technologies, products and services. Companies that have expertise in marketing and providing technical electronic services to government
entities compete with us by further developing their services and increasing their focus on this piece of their business and market shares. Examples of
companies that may compete and/or currently compete with us are the following:

consumer-oriented application service providers for government,
such as EzGov.com.

Many of our potential competitors are national or
international in scope and may have greater resources than we do. These resources could enable our potential competitors to initiate severe price cuts
or take other measures in an effort to gain market share. Additionally, in some geographic areas, we may face competition from smaller consulting firms
with established reputations and political relationships with potential government partners. If we do not compete effectively or if we experience any
pricing pressures, reduced margins or loss of market share resulting from increased competition, our business and financial condition may be adversely
affected.

Government Regulation

There are currently few laws or regulations that
specifically regulate communications or commerce on the Internet. Laws and regulations may be adopted in the future, however, that address these issues
including user privacy, pricing, and the characteristics and quality of products and services. An increase in regulation or the application of existing
laws to the Internet could significantly increase our cost of operations and harm our business. Additionally, state public utility commissions
generally have declined to review potential regulation of such services, but may chose to do so in the future. As a result, our business and financial
condition could be harmed.

Intellectual Property and Proprietary Rights

We rely on a combination of nondisclosure and other
contractual arrangements with governments, our employees and third parties, and privacy and trade secret laws to protect and limit the distribution of
the proprietary applications, documentation and processes we have developed in connection with the eGovernment services we offer. Despite our
precautions, third parties may succeed in misappropriating our intellectual property or independently developing similar intellectual property. If we
fail to adequately protect our intellectual property rights and proprietary information or if we become involved in litigation relating to our
intellectual property rights and proprietary technology, our business could be harmed. Any actions we take may not be adequate to protect our
proprietary rights, and other companies may develop technologies that are similar or superior to our proprietary technology.

Additionally, it is possible that we could in the
future become subject to claims alleging infringement of third-party intellectual property rights. Any claims could subject us to costly litigation,
and may require us to pay damages and develop non-infringing intellectual property or acquire licenses to the intellectual property that is the subject
of the alleged infringement. Additionally, licenses may not be available on acceptable terms or at all.

Litigation regarding intellectual property rights is
common in the Internet and software industries. We expect third-party infringement claims involving Internet technologies and software products and
services to increase. If an infringement claim is filed against us, we may be prevented from using certain technologies and may incur significant costs
resolving the claim.

12

We have in the past received letters suggesting that
we are infringing on the intellectual rights of others, and we may from time to time encounter disputes over rights and obligations concerning
intellectual property. Although we believe that our intellectual property rights are sufficient to allow us to market our existing services without
incurring liability to third parties, we cannot assure that our applications and services do not infringe on the intellectual property rights of third
parties.

In addition, we have agreed, and may agree in the
future, to indemnify certain of our customers against claims that our services infringe upon the intellectual property rights of others. We could incur
substantial costs in defending ourselves and our customers against infringement claims. In the event of a claim of infringement, we and our customers
may be required to obtain one or more licenses from third parties. We cannot assure that we or our customers could obtain necessary licenses from third
parties at a reasonable cost or at all.

After termination of our contracts, it is possible
that governments and their successors and affiliates may use their right of use license rights to the software programs and other applications we have
developed for them in the operation of their portals to operate the portals themselves. Inadvertently, they also may allow our intellectual property or
other information to fall into the hands of third parties, including our competitors. In one case, after completion of one of our government contracts,
a government claimed that it owned all the software written by NIC employees pursuant to the contract, a claim we vigorously and successfully
disputed.

Employees

As of December 31, 2004, we had 288 full-time
employees, of which 23 were working in corporate operations 21 were in our software & services businesses and 244 were in our outsourced portal
businesses. Our future success will depend, in part, on our ability to continue to attract, retain and motivate highly qualified technical and
management personnel. From time to time, we also employ independent contractors to support our application development, marketing, sales and support
and administrative organizations. Our employees are not covered by any collective bargaining agreement, and we have never experienced a work stoppage.
We believe that our relations with our employees are good.

Other Risk Factors Affecting Our Business

We have incurred significant net losses in the past

We expanded rapidly following our initial public
offering in July 1999 and incurred substantial net losses through mid-2002 primarily as a result of our acquired software & services businesses. We
incurred net losses of approximately $7.6 million for the year ended December 31, 2002, $77.4 million for the year ended December 31, 2001, $40.3
million for the year ended December 31, 2000 and $10.7 million for the year ended December 31, 1999. However, as part of a broad strategic refocusing
of the Company on our profitable core outsourced portal business during 2002, we exited our eProcurement business, NIC Commerce, decided to wind down
our transportation business, IDT, and restructured the other software & services businesses in an effort to accelerate our path to profitability.
As a result, the Company became profitable in the second half of 2002 and has been profitable since that time. Further, even though we expect to be
profitable in 2005 and beyond, we may not be able to sustain or increase profitability on a quarterly or annual basis thereafter. We will need to
generate significantly higher revenues while containing costs and operating expenses if we are to achieve growing profitability. We cannot be certain
that our revenues will continue to grow or that we will ever achieve sufficient revenues to remain profitable on a long-term, sustained
basis.

We may need more working capital to fund operations and expand our
business

We believe that our current financial resources will
be sufficient to meet our present working capital and capital expenditure requirements for at least the next twelve months. However, we may need to
raise additional capital before this period ends to further:

13



fund operations, including the costs to fund our contract with
the California Secretary of State and subcontractors on that project;



collateralize letters of credit, which the Company is required
to post as collateral for performance on certain of its outsourced government portal contracts and as collateral for certain performance
bonds;



support our expansion into other states and government agencies
beyond what is contemplated in 2005 if unforeseen opportunities arise;



expand our product and service offerings beyond what is
contemplated in 2005 if unforeseen opportunities arise;



respond to unforeseen competitive pressures; and



acquire complementary technologies beyond what is contemplated
in 2005 if unforeseen opportunities arise.

Our future liquidity and capital requirements will
depend upon numerous factors, including the success of our existing and new service offerings and potentially competing technological and market
developments. However, any projections of future cash flows are subject to substantial uncertainty. If current cash, lines of credit and cash generated
from operations are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity securities, issue debt securities or
increase our working capital line of credit. The sale of additional equity securities could result in dilution to the Companys shareholders. From
time to time, we expect to evaluate the acquisition of or investment in businesses and technologies that complement our various eGovernment businesses.
Acquisitions or investments might impact the Companys liquidity requirements or cause the Company to sell additional equity securities or issue
debt securities. There can be no assurance that financing will be available in amounts or on terms acceptable to the Company, if at all. If adequate
funds were not available on acceptable terms, our ability to develop or enhance our applications and services, take advantage of future opportunities
or respond to competitive pressures would be significantly limited. This limitation could harm our business, results of operations and financial
condition.

Our corporate filings business has incurred losses under its fixed-fee contracts
in the past, and our results of operations could be harmed if the costs that this business incurs to meet contractual commitments exceed our current
estimates

Our corporate filings business, NIC Conquest,
develops and delivers applications, typically for a fixed development fee, that improve the back-office administration of government records and better
enable electronic filing and distribution of business entity and UCC records for secretaries of state. In the fourth quarter of 1998, we determined
that the balance of revenues remaining to be recognized under our existing contractual obligations was not expected to cover anticipated costs of
developing and implementing the related applications. Estimated costs in excess of fixed contract prices of $1.3 million for completing these
applications were expensed in the fourth quarter of 1998. We accrued additional anticipated losses of $1.1 million in 1999, $1.4 million in 2000, and
$6.0 million in 2001 based on revised estimates relating to our then-existing contracts. In 2002, we accrued approximately $3.5 million in anticipated
losses due to cost overruns on contracts in Arkansas, Minnesota and Oklahoma. We have fulfilled all obligations under our contracts with the states of
Minnesota and Oklahoma, and the Arkansas system is currently in the maintenance phase. It is possible that our costs will similarly exceed revenues in
the future, as a result of unforeseen difficulties in the creation of an application called for in a contract, unforeseen challenges in ensuring
compatibility with existing systems, rising development, subcontractor and personnel costs, delays in completing a contract, or other reasons. If this
occurs, particularly on our contract with the California Secretary of State, our results of operations, financial condition and cash flows could be
seriously harmed.

As part of our business strategy, we have made and
may continue to make acquisitions or enter into strategic alliances that we believe will complement our existing businesses, increase traffic to our
government clients sites, enhance our services, broaden our software and applications offerings or technological capabilities or increase our
profitability. These acquisitions and future acquisitions or joint ventures could present numerous risks and uncertainties, including:

14



difficulties in the assimilation of operations, personnel,
technologies and information systems of the acquired companies;



the inability to successfully market, distribute, deploy and
manage new products and services that we have limited or no experience in managing;



the diversion of managements attention from our core
business;



the risk that an acquired business will not perform as
expected;



risks associated with entering markets in which we have limited
or no experience;

adverse effects on existing business relationships with existing
suppliers and customers;



potentially dilutive issuances of equity securities, which may
be freely tradable in the public market;



erosion of our brand equity in the eGovernment or financial
markets;



impairment, restructuring and other charges; and



the incurrence of debt or other expenses related to goodwill and
other intangible assets.

We cannot be sure that any acquisitions we may
announce will ultimately close. Moreover, even after we close such transactions, we cannot assure that we will be able to successfully integrate the
new businesses or any other businesses, products or technologies we may acquire in the future. For example, in the third and fourth quarters of 2001,
we recorded impairment losses totaling $37.0 million and $12.5 million, respectively, relating to our NIC Commerce, NIC Technologies and NIC Conquest
businesses, all of which were acquired since the third quarter of 1999. Also, in the third quarter of 2000 and the fourth quarter of 2001, we recorded
restructuring charges totaling $0.7 million and $0.4 million, respectively, relating to our NIC Commerce and NIC Technologies businesses. Additionally,
in the second quarter of 2002, we recorded a $1.3 million impairment loss relating to our IDT business, which was acquired in October 2000, and an
impairment loss totaling $3.0 million relating to our AOL business. For additional information on certain of these impairment charges, see Note 4 in
the Notes to Consolidated Financial Statements included in this Form 10-K.

Because we have portal outsourcing contracts with a limited number of
governments, the termination of certain of these contracts may harm our business

Currently, the majority of our revenues are derived
from the operation of our outsourced portal businesses. We have portal contracts with 23 governments. These contracts typically have initial terms of
three to five years with optional renewal periods of one to five years. However, any renewal is optional and a government may terminate its contract
prior to the expiration date upon specific cause events that are not cured within a specified period or, in some cases, upon passing legislation.
Additionally, the contracts under which we provide management and development services can be terminated without cause on a specified period of notice.
The loss of one or more of our larger state portal partners, such as Indiana or Virginia, if not replaced, could dramatically reduce our revenues. If
these revenue shortfalls occur, our business and financial condition would be harmed. We cannot be certain if, when or to what extent governments might
fail to renew or terminate any or all of their contracts with us.

We may face damage to our professional reputation if our partners are not
satisfied with our services

We depend to a large extent on our relationships
with our government partners, our reputation for high-quality professional services and commitment to preserving public trust to attract and retain
customers. As a result, if one of our government partners is not satisfied with our services, it may be more damaging in our business than in other
businesses. Moreover, if we fail to meet our contractual obligations, we could be subject to legal liability or loss of customer
relationships.

15

We may be unable to obtain future contracts through the request for proposal
process

A high percentage of our current revenues is derived
from contracts with governments and government agencies that operate under special rules that apply to government purchasing. Where this process
applies, there are special rules that typically require open bidding by possible service providers like us against a list of requirements established
by governments under existing or specially-created procedures. To respond successfully to these requests for proposals, commonly known as RFPs, we must
estimate accurately our cost structure for servicing a proposed contract, the time required to establish operations for the proposed client and the
likely terms of any other proposals submitted. We also must assemble and submit a large volume of information within the strict time schedule mandated
by an RFP. Whether or not we are able to respond successfully to RFPs in the future will significantly impact our business. We cannot guarantee that we
will win any bids in the future through the RFP process, or that any winning bids will ultimately result in contracts. Even though we have broadened
our service offerings, we still depend on the RFP process for a substantial part of our future contracts. Therefore, our business, results of
operations and financial condition would be harmed if we fail to obtain profitable future contracts through the RFP process.

We may be unable to sustain the usage levels of current services that provide a
significant percentage of our revenues

We obtain a high proportion of our revenues from a
limited number of services. Transaction-based fees charged for access to motor vehicle records through our insurance industry records exchange network
accounted for over 55% of our consolidated revenues and 63% of our portal revenues for the year ended December 31, 2004 and are expected to continue to
account for a significant portion of our revenues in the near future. Regulatory changes or the development of alternative information sources could
materially reduce our revenues from this service. A reduction in revenues from currently popular services would harm our business, results of
operations and financial condition.

If our potential customers are not willing to switch to or adopt our online
governmental portals and other electronic services, our growth and revenues will be limited

The failure to generate a large customer base would
harm our growth and revenues. This failure could occur for several reasons. Our future revenues and profits depend upon the widespread acceptance and
use of the Internet as an effective medium for accessing public information, particularly as a medium for government filings. We cannot assure that
customer acceptance and use of the Internet will continue to grow. Additionally, we face intense competition in all sectors of our business. As a
result, our efforts to create a larger customer base may be more difficult than expected even if we are perceived to offer services superior to those
of our competitors. Further, because the government-to-citizen and government-to-business portal access and electronic filing market is relatively new,
potential customers in this market may be confused or uncertain about the relative merits of each eGovernment application and of which application to
adopt, if any. Confusion and uncertainty in the marketplace may inhibit customers from adopting our applications, which could harm our business,
results of operations and financial condition.

The fees we collect for many of our services are subject to regulation that
could limit growth of our revenues and profitability

Under the terms of our outsourced portal government
contracts, we remit a portion of the fees we collect to state agencies. Generally, our contracts provide that the amount of any fees we retain is set
by governments to provide us with a reasonable return or profit. We have limited control over the level of fees we are permitted to retain. Our
business, results of operations and financial condition may be harmed if the level of fees we are permitted to retain in the future is too low or if
our costs rise without a commensurate increase in fees.

Our portal revenues could be harmed as a result of severe government budget
deficits

Although the majority of our portal revenues are
derived from fees we charge to users for transactions conducted through our portals, approximately 7% of our portal revenues in 2004 were derived from
software development or portal management services paid directly to us by governments on a time-and-materials or fixed fee basis. In the event of
severe budget deficits, our government clients may be required to curtail discretionary spending on such projects and our portal revenues could be
harmed.

16

Because a major portion of our current revenues is generated from a small number
of users, the loss of any of these users may harm our business and financial condition

A significant portion of our revenues is derived
from data resellers use of our portals to access motor vehicle records for sale to the automobile insurance industry. For the year ended December
31, 2004, one of these data resellers, ChoicePoint, accounted for approximately 46% of our portal revenues and 40% of our consolidated revenues. It is
possible that these users will develop alternative data sources or new business processes that would materially diminish their use of our portals. The
loss of all or a substantial portion of business from any of these entities would harm our business and financial condition.

We may lose the right to the content distributed through our outsourced portals,
which is provided to us entirely by government entities

We do not own or create the content distributed
through our outsourced portals. We depend on the governments with which we contract to supply information and data feeds to us on a timely basis to
allow businesses and citizens to complete transactions and obtain government information. We cannot assure that these data sources will continue to be
available in the future. Government entities could terminate their contracts to provide data. Changes in regulations could mean that governments no
longer collect some types of data or that the data is protected by more stringent privacy rules preventing uses now made of it. Moreover, our data
sources are not always subject to exclusive agreements, so that data included in our services also may be included in those of our potential
competitors. In addition, we are dependent upon the accuracy and reliability of government computer systems and data collection for the content of our
portals. The loss or the unavailability of our data sources in the future, or the loss of our exclusive right to distribute some of the data sources,
could harm our business, results of operations and financial condition.

The growth in our revenues may be limited by the number of governments that
choose to provide eGovernment services and to adopt our business model and by the finite number of governments with which we may contract for our
eGovernment services

Our revenues are generated principally from
contracts with state governments to provide eGovernment services on behalf of those governments to complete transactions and distribute public
information electronically. The growth in our revenues largely depends on government entities adopting our public/private model. We cannot assure that
government entities will choose to provide eGovernment services at all, or that they will not provide such services themselves without private
assistance or adopting our model.

In addition, as there is a finite number of states
remaining with which we can contract for our services, future increases in our revenues may depend in part on our ability to expand our business model
to include multi-state cooperative organizations, local governments and federal agencies and to broaden our service offerings to diversify our revenue
streams across our lines of business. We cannot assure that we will succeed in expanding into new markets, broadening our service offerings, or that
our services will be adaptable to those new markets.

Our business with various government entities often requires specific government
legislation to be passed for us to initiate and maintain our government contracts

Because a central part of our business includes the
execution of contracts with governments under which we remit a portion of user fees charged to businesses and citizens to state agencies, it is often
necessary for governments to draft and adopt specific legislation before the government can circulate an RFP to which we can respond. Furthermore, the
maintenance of our government contracts requires the continued acceptance of enabling legislation and any implementing regulations. In the past,
various entities that use the portals we operate to obtain government information have challenged the authority of governments to electronically
provide these services exclusively through portals like those we operate. A successful challenge in the future could result in a proliferation of
alternative ways to obtain these services, which would harm our business, results of operations and financial condition. The repeal or modification of
any enabling legislation would also harm our business, results of operations and financial condition.

17

Because a large portion of our business relies on a contractual bidding process
whose parameters are established by governments, the length of our sales cycles is uncertain and can lead to shortfalls in revenues

Our dependence on a bidding process to initiate many
new projects, the parameters of which are established by governments, results in uncertainty in our sales cycles because the duration and the
procedures for each bidding process vary significantly according to each government entitys policies and procedures. The time between the date of
initial contact with a government for a bid and the award of the bid may range from as little as 180 days to up to 36 months. The bidding process is
subject to factors over which we have little or no control, including:



political acceptance of the concept of government agencies
contracting with third parties to distribute public information, which has been offered traditionally only by the government agencies and often without
charge;



the internal review process by the government agencies for bid
acceptance;



the need to reach a political accommodation among various
interest groups;



changes to the bidding procedure by the government
agencies;



changes to state legislation authorizing governments
contracting with third parties to distribute
public information;



changes in government administrations;



the budgetary restrictions of government entities;



the competition generated by the bidding process;
and



the possibility of cancellation or delay by the government
entities.

We are dependent on the bidding process for a
significant part of our business. Therefore, any material delay in the bidding process, changes to the bidding practices and policies, the failure to
receive the bid or the failure to execute a contract may disrupt our financial results for a particular period and harm our financial
condition.

The seasonality of use for some of our eGovernment services may harm our fourth
quarter results of each calendar year

The use of some of our eGovernment services is
seasonal, particularly the accessing of drivers records, resulting in lower revenues from this service in the fourth quarter of each calendar
year, due to the smaller number of business days in this quarter and a lower volume of transactions during the holiday period. As a result, seasonality
could cause our quarterly results to fluctuate, which could harm our business and financial condition and could harm the trading price of our common
stock.

Our quarterly results of operations may be volatile and difficult to predict. If
our quarterly results of operations fail to meet the expectations of public market analysts or investors, the market price of our common stock may
decrease significantly

Our future revenues and results of operations may
vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control, and any of which may harm our
business. These factors include:



the commencement, completion or termination of contracts during
any particular quarter;



the introduction of new eGovernment services by us or our
competitors;



technical difficulties or system downtime affecting the Internet
generally or the operation of our eGovernment services;



the amount and timing of operating costs and capital
expenditures relating to the expansion of our business operations and infrastructure;

18



the result of negative cash flows due to capital investments;
and



the incurrence of significant charges related to
acquisitions.

Due to the factors noted above, our revenues in a
particular quarter may be lower than we anticipate and if we are unable to reduce spending in that quarter, our results of operations for that quarter
may be harmed. One should not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. It is
possible that in some future periods our results of operations may be below the expectations of public market analysts and investors. If this occurs,
the price of our common stock may decline.

If we fail to coordinate or expand our operational procedures and controls, we
may not effectively manage our growth

Our growth rate may increase rapidly in response to
the acceptance of our services under new or existing government contracts. If we cannot manage our growth effectively, we may not be able to coordinate
the activities of our technical, accounting and marketing staffs, and our business could be harmed. We intend to plan for the acceptance of new bids by
a number of governmental entities so that we may be ready to begin operations as soon as possible after acceptance of a bid. Additionally, we plan to
continue our expansion of eGovernment services into new government markets. As part of this plan of growth, we must implement new operational
procedures and controls to expand, train and manage our employees and to coordinate the operations of our various subsidiaries. If we cannot manage the
growth of our government portals, staff, software installation and maintenance teams, offices and operations, our business may be
harmed.

We may be unable to hire, integrate or retain qualified personnel

The growth in our business has resulted in an
increase in the responsibilities for both existing and new management personnel. Some of our personnel are presently serving in more than one executive
capacity. The loss of any of our executives could harm our business.

In addition, we expect that we will need to hire
additional personnel in all areas in 2005, including general managers for new operations in jurisdictions in which we obtain contracts. We may not be
able to retain our current key employees or attract, integrate or retain other qualified employees in the future. If we do not succeed in attracting
new personnel or integrating, retaining and motivating our current personnel, our business could be harmed. In addition, new employees generally
require substantial training in the presentation, policies and positioning of our government portals and other services. This training will require
substantial resources and management attention.

To be successful, we must develop and market comprehensive, efficient,
cost-effective and secure electronic access to public information and new services

Our success depends in part upon our ability to
attract a greater number of Internet users to access public information electronically by delivering a comprehensive composite of public information
and an efficient, cost-effective and secure method of electronic access and transactions. Moreover, in order to increase revenues in the future, we
must continue to develop services that businesses and citizens will find valuable, and there is no guarantee that we will be able to do so. If we are
unable to develop services that allow us to attract, retain and expand our current user base, our revenues and future results of operations may be
harmed. We cannot assure that the services we offer will appeal to a sufficient number of Internet users to generate continued revenue growth. Our
ability to attract Internet users to our government portals depends on several factors, including:



the comprehensiveness of public records available through our
government portals;



the perceived efficiency and cost-effectiveness of accessing
public records electronically;



the effectiveness of security measures;



the increased usage and continued reliability of the Internet;
and



the user acceptance of our online applications and
services.

19

Deficiencies in our performance under a government contract could result in
contract termination, reputational damage or financial penalties

Each government entity with which we contract for
outsourced portal services has the authority to require an independent audit of our performance. The scope of audits could include inspections of
income statements, balance sheets, fee structures, collections practices, service levels and our compliance with applicable laws, regulations and
standards. We cannot assure that a future audit will not find any material performance deficiencies that would result in an adjustment to our revenues
and result in financial penalties. Moreover, the consequent negative publicity could harm our reputation among other governments with which we would
like to contract. All of these factors could harm our business, results of operations and financial condition.

We may be unable to integrate new technologies and industry standards
effectively

Our future success will depend on our ability to
enhance and improve the responsiveness, functionality and features of our services in accordance with industry standards and to address the
increasingly sophisticated technological needs of our customers on a cost-effective and timely basis. Our ability to remain competitive will depend, in
part, on our ability to:



enhance and improve the responsiveness, functionality and other
features of the government portals we offer;



continue to develop our technical expertise;



develop and introduce new services, applications and technology
to meet changing customer needs and preferences; and



influence and respond to emerging industry standards and other
technological changes in a timely and cost-effective manner.

We cannot assure that we will be successful in
responding to the above technological and industry challenges in a timely and cost-effective manner. If we are unable to integrate new technologies and
industry standards effectively, our results of operations could be harmed.

We depend on the increasing use of the Internet and on the growth of online
government information systems. If the use of the Internet and eGovernment information systems does not grow as anticipated, our business will be
seriously harmed

Our business depends on the increased acceptance and
use of the Internet as a medium for accessing public information and completing government filings. Rapid growth in the use of the Internet is a
relatively recent phenomenon. As a result, acceptance and use may not continue to develop at historical rates and a sufficiently broad base of
individual and business customers may not adopt or continue to use the Internet as a medium for accessing government portals and other online services.
Demand and market acceptance for recently introduced services over the Internet are subject to a high level of uncertainty, and there exist few proven
services.

Our business would be seriously harmed
if:



use of the Internet and other online services does not continue
to increase or increases more slowly than expected; or



the technology underlying the Internet and other online services
does not effectively support any expansion that may occur.

If the Internet infrastructure fails to develop or be adequately maintained, our
business would be harmed because users may not be able to access our government portals

The Internet has experienced, and is expected to
continue to experience, significant growth in the number of users and amount of traffic. If the Web continues to experience increased numbers of users,
frequency of use or increased bandwidth requirements, the Internet infrastructure may not be able to support these increased demands

20

or perform reliably. The Internet has experienced a variety of
outages and other delays as a result of damage to portions of its infrastructure, and could face such outages and delays in the future. These outages
and delays could reduce the level of Internet usage and traffic on our government portals. Such outages and delays would also hinder our
customers ability to complete eGovernment transactions. In addition, the Internet could lose its viability due to delays in the development or
adoption of new standards and protocols to handle increased levels of activity or due to increased governmental regulation. If the Internet
infrastructure is not adequately developed or maintained, use of our government portals and our government-to-citizen and government-to-business
services may be reduced.

Our success depends on the increase in Internet
usage generally and in particular as a means to access public information electronically. This in part requires the development and maintenance of the
Internet infrastructure. If this infrastructure fails to develop or be adequately maintained, our business would be harmed because users may not be
able to access our government portals. Among other things, this development and maintenance will require a reliable network backbone with the necessary
speed, data capacity, security and timely development of complementary products for providing reliable Internet access and services.

We may be held liable for content that we obtain from government
agencies

Because we aggregate and distribute sometimes
private and sensitive public information over the Internet, we may face potential liability for defamation, libel, negligence, invasion of privacy,
copyright or trademark infringement, and other claims based on the nature and content of the material that is published on our outsourced government
portals. Most of the agreements through which we obtain consent to disseminate this information do not contain indemnity provisions in our favor. These
types of claims have been brought, sometimes successfully, against online services and Web sites in the past. We cannot assure that our general
liability or errors and omissions insurance will be adequate to indemnify us for all liability that may be imposed. Any liability that is not covered
by our insurance or is in excess of our insurance coverage could severely harm our business operations and financial condition.

Concerns over transactional security may hinder the growth of our
business

A significant barrier to electronic commerce is the
secure transmission of confidential information over public networks. Any breach in our security could expose us to a risk of loss or litigation and
possible liability. We rely on encryption and authentication technology licensed from third parties to provide secure transmission of confidential
information. As a result of advances in computer capabilities, new discoveries in the field of cryptography or other developments, a compromise or
breach of the algorithms we use to protect customer transaction data may occur. Because we provide information released from various government
entities, we may represent an attractive target for security breaches.

A compromise of our security or a perceived
compromise of our security could severely harm our business. A party who is able to circumvent our security measures could misappropriate proprietary
information, including customer credit card information, or cause interruptions or direct damage to our government portals. Also, should hackers obtain
sensitive data and information, or create bugs or viruses in an attempt to sabotage the functionality of our applications and services, we may receive
negative publicity, incur liability to our customers or lose the confidence of the governments with which we contract, any of which may cause the
termination or modification of our government contracts.

We may be required to expend significant capital and
other resources to protect against the threat of security breaches or to alleviate problems caused by these breaches. However, protection may not be
available at a reasonable price or at all.

Our systems may fail or limit user traffic, which could harm our business,
results of operations and financial condition

Most of our communications hardware and computer
hardware operations for delivering our eGovernment services are located individually in each state or city where we provide those services. We cannot
assure that during the occurrence of fire, floods, earthquakes, power loss, telecommunications failures, break-ins and similar events

21

that the modem banks and direct dial-up
connections we have to serve as back-up systems will not prevent damage to our systems or cause interruptions to our services. Computer viruses,
electronic break-ins or other similar disruptive problems could cause users to stop visiting our government portals and could cause our partners to
terminate agreements with us. If any of these circumstances occurred, our business could be harmed. Our insurance policies may not adequately
compensate us for any losses that may occur due to any failures of or interruptions in our systems.

Our government portals must accommodate a high
volume of traffic and deliver frequently updated information. These government portals may experience interruptions due to any failure or delay by
government agencies in the transmission or receipt of this information. Due to holidays and technical problems with state computer systems, our Web
sites have experienced slower response times or decreased traffic in the past and may experience the same incidents in the future. In addition, our
users depend on Internet service providers, online service providers and other Web site operators for access to our government portals and other online
government-to-citizen and government-to-business services. Many of these providers and operators have experienced significant outages in the past due
to system failures unrelated to our systems, holidays and heavy user traffic, and could experience the same outages, delays and other difficulties in
the future. Any of these system failures could harm our business, results of operations and financial condition.

Compliance
with changing regulation of corporate governance and public disclosure may result in additional expenses

Changing laws, regulations and
standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National
Market rules, are creating uncertainty for companies such as ours. These new or changed laws, regulations and standards are subject to varying
interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is
provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by
ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure.
As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased
general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. In
particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of
our internal controls over financial reporting and our independent registered public accounting firms audit of that assessment has required the
commitment of significant financial and managerial resources. Further, our board members, chief executive officer and chief financial officer could
face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and
retaining qualified board members and executive officers, which could harm our business. If our efforts to comply with new or changed laws, regulations
and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be
harmed.

ITEM
2. PROPERTIES

Our principal administrative
office occupies a total of approximately 7,500 square feet of leased space at 10540 South Ridgeview Road, Olathe, Kansas 66061. All of our subsidiaries
also lease their facilities. We believe our current facilities are adequate to meet our needs for the foreseeable future. We do not anticipate
acquiring property or buildings in the foreseeable future.

ITEM
3. LEGAL PROCEEDINGS

None.

ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a
vote of the shareholders during the fourth quarter of fiscal 2004.

22

PART II

ITEM 5.

MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS

Our stock trades on the Nasdaq National Market under
the symbol EGOV. The following table shows the range of high and low closing sales prices reported on the Nasdaq National Market for the
periods indicated. On February 11, 2005, the closing price of our common stock was $4.78.

Fiscal
Year Ended December 31, 2003

High

Low

First
Quarter

$

1.95

$

1.46

Second
Quarter

$

3.09

$

1.71

Third
Quarter

$

5.03

$

2.92

Fourth
Quarter

$

8.47

$

4.62

Fiscal
Year Ended December 31, 2004

High

Low

First
Quarter

$

8.85

$

5.25

Second
Quarter

$

7.15

$

5.10

Third
Quarter

$

7.15

$

5.17

Fourth
Quarter

$

5.50

$

4.15

As of February 11, 2005, there were approximately
355 holders of record of shares of our common stock.

Dividend policy

Other than dividends paid while we were an S
corporation, we have never declared or paid any cash dividends on shares of our common stock and do not anticipate declaring or paying dividends on our
common stock in the foreseeable future. We expect that we will retain all available earnings generated by our operations for the development and growth
of our business. Any future determination as to the payment of dividends will be made at the discretion of our Board of Directors and will depend on
our operating results, financial condition, capital requirements, general business conditions and such other factors as the Board of Directors deems
relevant.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data set forth
below should be read in conjunction with the consolidated financial statements and related notes, and Managements Discussion and Analysis
of Financial Condition and Results of Operations, included in this Form 10-K.

From September 1999 through October 2000, we
acquired four companies and formed one business alliance that comprised the majority of our software & services businesses. All business
acquisitions in 1999 and 2000 were accounted for as purchases and the results of the acquired companies operations have been included in the
Companys consolidated statements of operations from the respective dates of acquisition. Throughout this period of rapid expansion, and through
the first half of 2002, we incurred substantial operating and net losses primarily as a result of these businesses. Included in results of operations
for 2000, 2001 and 2002 were substantial charges relating to the amortization of intangible assets and goodwill arising from the acquisition of these
businesses and formation of this business alliance. In addition, over the past several years, these businesses have undergone substantial
organizational restructurings and consolidations and have incurred significant impairment losses, restructuring charges and contract losses. In 2001,
we recorded impairment losses totaling $49.5 million relating to our NIC Commerce, NIC Technologies and NIC Conquest businesses. In 2002, we recorded
impairment losses totaling $4.3 million relating to our AOL and IDT businesses. In 2000 and 2001, we recorded restructuring charges totaling $638,000
and $374,000, respectively, relating primarily to our NIC Commerce and NIC Technologies businesses. In 2000, we determined that the balance of revenues
remaining to be recognized under NIC Conquests existing contractual obligations was not expected to cover anticipated costs of developing and
implementing the

23

related applications. Estimated costs in excess
of fixed contract prices of $1.4 million for completing these applications were expensed in 2000. We accrued additional anticipated losses of $6.0
million in 2001 and $3.5 million in 2002 based on revised estimates relating to then-existing contracts. We also incurred substantial non-operating
losses in 2000, 2001 and 2002 from our equity method investments in affiliates and joint ventures totaling $6.5 million, $3.3 million and $1.2 million,
respectively. At December 31, 2004, we hold no such investments accounted under the equity method.

As part of a broad strategic refocusing of the
Company on our profitable core outsourced portal business in mid-2002, we exited our eProcurement business, decided to wind down our transportation
businesses and restructured the other software & services businesses in an effort to accelerate our path to profitability. The results of
operations of our eProcurement business, NIC Commerce, have been classified as discontinued operations for all periods presented. Loss from
discontinued operations for 2000, 2001 and 2002 totaled $4.3 million, $6.5 million and $2.0 million, respectively. We became profitable in the second
half of 2002 and have been profitable since that time. We expect the Company to continue to be profitable and have focused the business on operations
we believe have demonstrable ability to produce positive net income and sustainable cash flow in the future. However, any projections of future results
of operations and cash flows are subject to substantial uncertainty.

For additional information on the business
combinations and acquisitions we have completed since 1999, discontinued operations and other significant items affecting results for the periods
presented, refer to Notes 1, 2, 4, 6 and 10 in the Notes to Consolidated Financial Statements included in this Form 10-K.

Year Ended December 31,

2000

2001

2002

2003

2004

(in thousands, except per share data)

Consolidated
Statement of Operations Data:

Total
revenues

$

23,341

$

37,020

$

47,545

$

50,831

$

55,762

Operating
income (loss)

(45,280

)

(87,502

)

(7,930

)

7,338

11,800

Income (loss)
from continuing operations

(35,957

)

(70,919

)

(5,575

)

6,328

7,105

Net income
(loss)

(40,278

)

(77,444

)

(7,610

)

6,328

7,105

Income (loss)
per share from continuing operations  basic and diluted

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Caution about Forward-Looking Statements

This Form 10-K includes forward-looking
statements about future financial results, future business changes and other events that havent yet occurred. For example, statements like we
expect, we believe, we plan, we intend or we anticipate are forward-looking statements. Investors
should be aware that actual operating results and financial performance may differ materially from our expressed expectations because of risks and
uncertainties about the future including risks related to economic and competitive conditions. In addition, we will not necessarily

24

update the information in this Form 10-K if any
forward-looking statement later turns out to be inaccurate. Details about risks affecting various aspects of our business are discussed throughout this
Form 10-K. Investors should read all of these risks carefully.

What We Do  An Executive Summary

We are a leading provider of eGovernment services
that help governments use the Internet to reduce costs and provide a higher level of service to businesses and citizens. We accomplish this currently
through two primary divisions: our core portal outsourcing businesses and our software & services businesses. In our core business, portal
outsourcing, we enter into contracts primarily with state governments and design, build and operate Web-based portals on their behalf. We enter into
long-term contracts, typically three to five years, and manage operations for each government partner through separate subsidiaries that operate as
decentralized businesses with a high degree of autonomy. Our portals consist of Web sites and applications that we build, which allow businesses and
citizens to access government information online and complete transactions, including applying for a permit, retrieving drivers license records
or filing a form or report. We help increase our government partners revenues by expanding the distribution of their information assets and
increasing the number of financial transactions conducted with governments. We do this by marketing portal services and soliciting users to complete
government-based transactions and to enter into subscriber contracts that permit users to access the portal and the government information contained
therein in exchange for transactional and/or subscription user fees. We are typically responsible for funding the up-front investment and ongoing
operational costs of the government portals. Our unique self-funding business model allows us to reduce our government partners financial and
technology risks and obtain revenues by sharing in the fees generated from eGovernment services. Our clients benefit because they gain a centralized,
customer-focused presence on the Internet. Businesses and citizens gain a faster, more convenient and more cost-effective means to interact with
governments.

On behalf of our government partners, we enter into
separate agreements with various agencies and divisions of the government to provide specific services and to conduct specific transactions. These
agreements preliminarily establish the pricing of the transaction and data access services we provide and the division of revenues between the Company
and the government agency. The government must approve prices and revenue sharing agreements. We generally own all the applications developed under
these contracts. After completion of a defined contract term, the government agency typically receives a perpetual, royalty-free license to the
applications for use only. If our contract were not renewed after a defined term, the government agency would be entitled to take over the portal in
place with no future obligation of the Company. In some cases, we enter into contracts to provide consulting, development and management services to
government portals in exchange for an agreed-upon fee.

Currently, we have contracts to provide portal
outsourcing services for eighteen states, sixteen of which are operated under our self-funding business model. Our closest competitors operate no more
than one state portal each. We also provide portal outsourcing services to five local governments.

Our objective is to strengthen our position as the
leading provider of Internet-based eGovernment services. Key strategies to achieve this objective include:



Renew all current outsourced government portal contracts

We will strive to obtain renewal of all currently profitable outsourced government portal contracts. In the history of our company, we have
not lost a contract renewal opportunity or re-bid process and are very proud of our highly reference-able list of government partners. In December
2002, we won a re-bid competition and signed a new contract for up to seven years with Kansas, which became our first state partner in 1991. In January
2004, we won a re-bid competition and signed a new contract for up to six years with Nebraska, which became our partner in 1995.



Win new portal contracts 
We intend to increase our
number of government partners by leveraging our strong relationships with current government partners and our reputation for providing proven
eGovernment services. We intend to continue marketing our services to new governments. Our expansion efforts include developing relationships and
sponsors throughout an individual government entity, pursuing strategic technology alliances, making presentations at conferences of government
executives with responsibility for

25

information technology policy, and developing contacts with
organizations that act as forums for discussions between these executives. In 2003, we entered into a two-year portal outsourcing contract with the
Commonwealth of Kentucky that includes renewal options for up to eight additional years
.



Increase transactional revenues from our existing government
portals 
We intend to increase transactional revenues from our existing government portals by building new applications and services and
increasing the adoption of existing portal applications and services. We will accomplish this with new services offerings and expanded marketing
initiatives. In addition, we will work closely with the governance entities in our partner portals to evaluate the pricing of new and existing services
to encourage higher usage and increased revenue streams. We plan to continue our development of new online transactional services that enable
government agencies to interact more effectively and efficiently with businesses, citizens and other government agencies. We will continue to work with
government agencies, professional associations and other organizations to better understand the current and future needs of our customers. We will
continue to work with our government partners to create awareness of the online alternatives to traditional government interaction through initiatives
such as informational brochures, government voicemail recordings and inclusion of Web site information on government communication materials. In
addition, we will continue to update our portals to highlight new government service information provided on the portals. We plan to work with
professional associations to directly and indirectly communicate to their members the potential convenience, ease of use and other benefits of the
services our portals offer.

In addition to overall portal revenue growth, which includes
both organic revenue growth and growth from new portal contract wins, an important financial metric that we use to gauge our success in increasing
transactional revenues in our existing portal businesses is same state revenue growth. We define same state revenue growth as the growth in revenues
from states in operation and generating DMV revenues for at least two full years. DMV revenues are transaction fees that we earn from the sale of
driver history records through the portals we operate. Our long-term goal is to grow same state revenues at 1520% per year. Same state portal
revenues grew 20% in 2004, 7% in 2003 and 15% in 2002. As more fully described below, our same state revenue growth in 2003 was lower than normal due
primarily to a 1% year-over-year decrease in same state DMV revenues. While we generally expect same state DMV revenues to grow only 1% to 3% per year,
we experienced an unusually large increase in same state DMV revenues in 2002 due in part to more robust U.S. automobile sales than in 2003. In 2004,
same state DMV revenues grew by 14% primarily due to modest online record DMV price increases in two of our portal states in late 2003 and one portal
state in late 2004. Historically, such price increases have been infrequent, and our ability to grow same state DMV revenues has been limited, as such
revenues have been driven by broader economic factors outside of our control.

An important component of same state revenue growth is the
growth in non-DMV transaction revenues, which are transaction fees generated by other means than from the sale of DMV records, for transactions
conducted primarily by business users and, to a lesser extent, consumer users through our portals. In 2004, same state non-DMV revenues grew at 39%, up
from 35% in 2003, but less than the 55% we achieved in 2002. We are able to grow non-DMV revenues by continually deploying new revenue generating
applications and by driving adoption of existing applications within our existing portal businesses. We believe the key factor in organically growing
our revenues is to continually focus on driving adoption, and on implementation of new non-DMV revenue generating applications.



Continue to aggressively grow operating margins and
profitability 
In addition to driving same state revenue growth, we will continue to increase profitability by driving cost containment
efforts throughout the Company and maintaining a lean organizational structure that fosters entrepreneurial decision-making and innovation and
accentuates the strong financial leverage of our business model.

An important financial metric that we use to gauge our success
in improving portal profitability is portal gross profit percentage, or gross profit rate, which is calculated by dividing portal gross profit (portal
revenues minus cost of portal revenues, excluding depreciation) by portal revenues. Our long-term outlook is for our portal gross profit rate to be in
the 4550% range. Our portal gross profit rate increased to 49% in 2004,

26

from 46% in 2003 and 43% in 2002. The increase in 2004 was
primarily attributable to a full year of operations from our Kentucky portal, and to a modest increase in our same state gross profit rate. New portal
contract wins can have a short-term negative impact on our gross profit percentage during the start-up phase of a portal, as we incur costs to develop
and implement the portal infrastructure prior to the time we begin to generate transaction revenues. Our portal gross profit could be similarly
impacted in the future if we are successful in winning new portal contracts. We carefully monitor our portal gross profit percentage to strike the
balance between generating a solid return for our shareholders and delivering value to our government partners through reinvestment in our portal
operations.

On a same state basis, our 2004 portal gross profit rate was
50%, an increase of less than 1% from 2003. While same state portal revenues grew by 20% in 2004, same state cost of portal revenues increased by
approximately 18%, primarily as a result of the addition of personnel in several of our portals due to our continued growth and reinvestment in our
core business. In addition, a growing percentage of our non-DMV revenues are generated from online applications whereby users pay for information or
transactions via credit cards. We typically earn a percentage of the credit card transaction amount, but also must pay an associated fee to the
merchant bank that processes the credit card transaction. We earn a lower gross profit percentage on these transactions as compared to our other
non-DMV applications. However, we anticipate these revenues and the associated merchant card fees to continue to increase in the future, as these
transactions contribute favorably to our operating income growth. Our same state gross profit rate was slightly less than 50% in 2003 and slightly less
than 48% in 2002. As discussed above, our long-term goal is to grow same state revenues at 1520% per year, while keeping same state cost of
portal revenue growth in the 710% range. As a result, we expect our same state gross profit rate to increase modestly on an annual
basis.

We also view selling & administrative costs, expressed as a
percentage of revenue, to be an important indicator of our success in keeping corporate level expenses flat year over year. Selling &
administrative costs as a percentage of revenue decreased to 22% in 2004, from 23% in 2003 and 28% in 2002. Going forward, we expect selling &
administrative costs as a percentage of revenues to continue to decline as our revenues grow and our corporate expenses remain relatively flat year
over year.

Finally, our consolidated operating margin (operating income or
loss divided by consolidated revenues) is an important measure of our overall profitability. This metric improved to 21% in 2004 from 14% in 2003 and
(17%) in 2002. We expanded rapidly following our initial public offering in July 1999 and incurred substantial operating losses through mid-2002
primarily as a result of our acquired software & services businesses, which are further discussed below. Throughout this time period, our core
outsourced portal operations have grown and have been profitable. As part of a broad strategic refocusing on our profitable core outsourced portal
business during 2002, we exited our eProcurement and transportation businesses and restructured the other software & services businesses in an
effort to accelerate our path to profitability. We became profitable in the second half of 2002 and have been profitable since that time. We have
focused the business on operations we believe have demonstrable ability to produce positive net income and sustainable cash flow in the future.
However, any projections of future results of operations and cash flows are subject to substantial uncertainty.

Overview of Business Models and Revenue Recognition

We classify our revenues and cost of revenues into
two categories: (1) portal and (2) software & services. The portal category includes revenues and cost of revenues primarily from our subsidiaries
operating government portals on an outsourced basis. The software & services category includes revenues and cost of revenues primarily from our
corporate filings, ethics & elections, transportation and AOL businesses. We currently derive revenue from three main sources:



transaction-based fees;



fees for managing portal operations; and



fees for application development.

27

Each of these revenue types and the corresponding
business models are further described below.

Our portal outsourcing businesses

We categorize our portal revenues according to the
underlying source of revenue. A brief description of each category follows:



DMV transaction-based
: these are transaction fees from
the sale of electronic access to driver history records, referred to as DMV records, from our state portals to data resellers, insurance companies and
other pre-authorized customers on behalf of our state partners, and are generally recurring.



Non-DMV transaction-based
: these are transaction fees
from other sources than the sale of DMV records, for transactions conducted by business users and consumer users through our portals, and are generally
recurring. For a representative listing of non-DMV services we currently offer through our portals, refer to Part I, Item 1 in this Form
10-K.



Portal management
: these are recurring fees paid to us by
our government partners for the operation of portals, which typically supplement transaction-based fees.



Software development
: these are fees from the performance
of software development projects and other time and materials services for our government partners. While we actively market these services, they may
not have the same degree of predictability as our transaction-based or portal management revenues.

The highest volume, most commercially valuable
service we offer is electronic access to DMV records through our insurance industry records exchange network. This service accounted for approximately
63% of our portal revenues in 2004, 62% in 2003 and 64% in 2002. We believe that while this application will continue to be an important source of
revenue, its contribution as a percentage of total revenues on an individual portal basis will decline modestly as other sources grow. ChoicePoint,
which resells these records to the auto insurance industry, accounted for approximately 46% of portal revenues in 2004, 47% in 2003 and 48% in 2002.
Portal revenues accounted for approximately 87% of our consolidated revenues in 2004, 79% in 2003 and 73% in 2002. We expect portal revenues as a
percentage of total revenues to continue to increase in future years as our portal business continues to grow and we continue to wind down certain of
our software & services businesses.

In our outsourced portal businesses for 2004, DMV
transaction-based revenues represented approximately 63% of portal revenues, non-DMV transaction-based revenues represented approximately 30%, software
development represented 6%, and portal management represented approximately 1%. We expect software development and portal management revenues as a
percentage of total portal revenues to decline in the future due to our focus on growing transaction-based revenues, which are more predictable and
recurring in nature. In 2004, approximately 90% of our transaction-based revenues related to business-to-government transactions, while the remaining
10% related to citizen-to-government transactions.

Transaction-based revenues from our outsourced state
portal business units are highly correlated to population, but are also affected by pricing policies established by government entities for public
records, the number and growth of commercial enterprises and the government entitys development of policy and information technology
infrastructure supporting electronic government.

ChoicePoint and other data resellers and companies
who access DMV records electronically through our insurance industry records exchange network have entered into contracts with the portals our
subsidiaries operate to request these records from the states of Alabama, Arkansas, Hawaii, Idaho, Indiana, Iowa, Kansas, Kentucky, Maine, Montana,
Nebraska, Oklahoma, Rhode Island, Tennessee, Utah and Virginia. Under the terms of these contracts, we provide data resellers with drivers
license and traffic records that vary by contract, for fees that currently range from $3.00 to $18.00 per record requested. The fees charged to all
entities that access DMV records are the same for records of a particular state. We typically collect the entire fee, of which a certain portion is
remitted to the state by statute. These contracts are generally self-renewing until canceled by one side or the other, and generally may be terminated
at any time after 60-days notice. These contracts may be terminated immediately at

28

the
option of any party upon a material breach of the contract by the other party.
Furthermore, these contracts are immediately terminable if the state statute allowing for
the public release of these records is repealed.

We charge for electronic access to records on a
per-record basis and, depending upon government policies, also on a fixed or sliding scale bulk basis. Our fees are set by negotiation with the
government agencies that control the records and are typically approved by a government sanctioned oversight body. We recognize revenues from
transactions (primarily transaction-based information access fees and filing fees) on an accrual basis net of the transaction fee due to the
government, and we bill end-user customers primarily on a monthly basis. We typically receive a majority of payments via electronic funds transfer and
credit card within 25 days of billing and remit payment to governments within 30 to 45 days of the transaction. The costs that we pay state agencies
for data access are accrued as accounts receivable and accounts payable at the time revenue from the access of public information is recognized. We
must remit a certain amount or percentage of these fees to government agencies regardless of whether we ultimately collect the fees. The pricing of
transactions varies by the type of transaction and by state.

Currently, under our contracts with the States of
New Hampshire and Vermont, we provide consulting, development and management services for these government portals predominantly under a time and
materials model.

We expense as incurred all employee costs to start
up, operate and maintain outsourced government portals as costs of performance under the contracts because, after the completion of a defined contract
term, the government entities with which we contract typically receive a perpetual, royalty-free license to the applications we developed. Such costs
are included in cost of portal revenues in the consolidated statements of operations.

Our software & services businesses

Corporate filings

Our corporate filings business derives the majority
of its revenues from fixed-price application development contracts and recognizes revenues on the percentage of completion method. The average size
contract for this business has historically been approximately $1 million to $3 million. However, as further discussed below, our five-year contract
with the California Secretary of State is valued at approximately $25 million. In 2004, our corporate filings business accounted for approximately 8%
of our consolidated revenues.

In September 2001, our corporate filings business
was awarded a five-year contract by the California Secretary of State to build an information management and retrieval system for the Business Programs
Division of the California Secretary of State. This contract is valued at approximately $25 million and is the largest government contract we have ever
been awarded. This award is both the nations largest state eGovernment filing initiative on record and the most comprehensive secretary of state
outsourced filing system project in the United States. The Web-enabled document management and filing system will increase efficiency and reduce
expenses for the State by eliminating paperwork and decreasing processing and turnaround times. Upon completion, the new system will allow agency
customers, primarily from the banking and legal communities, to search, retrieve, and submit documents online. Customers will also be able to pay fees
for a variety of transactions, including new incorporation document filings, trademark registrations, and Uniform Commercial Code filings. The contract
includes comprehensive back office document and revenue management systems, Web and Internet applications that will take approximately 90% of the
agencys Business Programs Divisions services online, and imaging and indexing of more than ten million historical document pages. We will
also provide three years of onsite support and maintenance for the system. We currently believe this contract will be profitable.

At December 31, 2004, our corporate filings business
was primarily engaged in servicing its contract with the California Secretary of State. This business is not actively marketing its applications and
services to new government entities.

29

Ethics & elections

Our ethics & elections business derives the
majority of its revenues from time and materials application development and maintenance outsourcing contracts and recognizes revenues as services are
provided. In 2004, our ethics & elections business accounted for approximately 4% of our consolidated revenues.

At December 31, 2004, our ethics & elections
business was primarily engaged in servicing its contracts with the Federal Election Commission and the state of Michigan.

Transportation

Our transportation business has historically derived
the majority of its revenues from cost-plus time and materials application development contracts with governments and recognizes revenues as services
are provided. Revenues from our transportation business were not significant in 2004. We decided to wind down our transportation business in 2002 and
do not expect to generate substantial revenues from this business in 2005. Our transportation business did not qualify as a discontinued operation as
of December 31, 2004.

AOL

In August 2000, we entered into an agreement with
America Online, Inc. to deliver government information, services and applications through AOLs Government Guide. NIC and AOL shared revenues
generated from the license or sale of advertisement on or through the Government Guide. We recognized our share of AOLs advertising revenues when
notified of the amount due from AOL, which is approximately one month after the advertisement is provided. We experienced a significant decrease in
revenues from our AOL business in 2003 as compared to prior periods due to weakness in AOLs online advertising operations. Our contract with AOL
expired on December 31, 2004, and was not renewed. Revenues from our AOL business were not significant in 2004.

Critical Accounting Policies

Many estimates and assumptions involved in the
application of generally accepted accounting principles have a material impact on reported financial condition and operating performance and on the
comparability of such reported information over different reporting periods. A critical accounting policy is one which is both important to the
portrayal of the Companys financial condition and results of operations and requires managements most difficult, subjective or complex
judgments, often as a result of the need to make estimates and assumptions about the effect of matters that are inherently uncertain. Our significant
accounting policies are described in Note 2 to the Notes to Consolidated Financial Statements included in this Form 10-K. We have identified the
policies below as critical to our business operations and the understanding of our results of operations. Note that the preparation of our consolidated
financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those
estimates.

Management has discussed the development and
selection of the critical accounting policies described below with the Audit Committee of the Board of Directors, and the Audit Committee has reviewed
the Companys disclosure relating to it in this Managements Discussion and Analysis of Financial Condition and Results of
Operations.

Application development contracts

Our corporate filings business, NIC Conquest,
derives the majority of its revenues from fixed-price application development contracts and recognizes revenues on the percentage of completion method,
utilizing costs incurred to date as compared to the estimated total costs for each contract. Revenues and profits from these contracts
are

30

based on managements estimates to complete
and are reviewed periodically, with adjustments recorded in the period in which the revisions are made. Use of the percentage of completion method
requires that management be able to reasonably estimate total contract costs and costs to complete at each reporting date. Any anticipated losses on
contracts are charged to operations as soon as they are determinable. We continuously review and reassess our estimates of contract
profitability.

Our corporate filings business has incurred
substantial losses under its fixed-price contracts in the past primarily due to cost overruns (as further discussed in Note 2 to the Notes to
Consolidated Financial Statements included in this Form 10-K). It is possible that our costs will similarly exceed revenues in the future, as a result
of unforeseen difficulties in the creation of an application called for in a contract, unforeseen challenges in ensuring compatibility with existing
systems, rising development, subcontractor and personnel costs or other reasons. If this occurs, particularly on our contract with the California
Secretary of State, which we currently expect to be profitable, our results of operations, financial condition and cash flows could be seriously
harmed. Because of the inherent uncertainties in estimating the costs of completion, it is at least reasonably possible that the estimate will change
in the near term.

Deferred income taxes

We recognize deferred income taxes for the tax
consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end
based on enacted laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation
allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

We have a recent history of unprofitable operations
primarily due to operating losses incurred in the software & services companies we have acquired since September 1999. These losses have generated
significant federal tax net operating losses, or NOLs. We had available at December 31, 2004, total NOL carryforwards for federal tax purposes of
approximately $59.4 million that will expire in the years 2020 ($22.0 million), 2021 ($27.1 million) and 2022 ($10.3 million), respectively. As
discussed above, we became profitable in the second half of 2002. We expect the Company to continue to be profitable and generate taxable income, and
have focused the business on operations we believe have demonstrable ability to produce positive taxable income and sustainable cash flow in the
future. We believe it is more likely than not that we will generate sufficient taxable income from future operations to fully utilize the NOL
carryforwards prior to expiration. Based on our current projections, we expect to fully utilize the NOL carryforwards by the end of 2008. The recorded
amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income during the carryforward
periods are reduced. There is considerable management judgment necessary to determine future taxable income, and accordingly, actual results could vary
significantly from such estimates. For additional discussion of deferred income taxes, see Deferred Tax Assets section below and Note 10 to
the Notes to Consolidated Financial Statements included in this Form 10-K. For the years ended December 31, 2003 and 2004, total net deferred tax
assets, including NOL carryforwards, were the largest asset included in our consolidated balance sheets and comprised approximately 41% and 34%,
respectively, of our total assets.

Goodwill, intangible assets and long-lived assets

As further discussed below, during 2002 we recorded
impairment losses totaling $4.3 million relating mostly to goodwill arising from the IDT acquisition and intangible assets relating to our AOL
business. In 2001, we recorded impairment losses totaling $49.5 million relating mostly to goodwill and intangible assets arising from business
combinations and software development costs. At December 31, 2003 and 2004, our recorded intangible assets were not significant. We had no goodwill
remaining after the IDT goodwill impairment loss recorded by the Company in 2002.

At each balance sheet date, and whenever events or
changes in circumstances warrant, management assesses the carrying value of long-lived assets for possible impairment based primarily on the ability to
recover the balances from expected future cash flows on an undiscounted basis. If the sum of the expected future cash flows on an undiscounted basis
were to be less than the carrying amount of the intangible asset, an impairment loss would be

31

recognized for the amount by which the carrying
value of the intangible asset exceeds its estimated fair value. We estimate future discounted and undiscounted cash flows and fair values based upon
historical performance, trends, and various other factors. A significant change in the assumptions underlying the cash flows or fair values could
result in a different determination of impairment loss and/or the amount of any impairment.

As further discussed in Note 4 in the Notes to
Consolidated Financial Statements included in this Form 10-K, in the second quarter of 2002, we exited our domestic eProcurement business entirely and
have classified the results of operations of NIC Commerce as discontinued operations for all periods presented.

IDT

During the second quarter of 2002, we identified
indicators of possible impairment of goodwill related to the IDT acquisition. The impairment indicators included, but were not limited to, the recent
underperformance of this business relative to plan, the expected underperformance of this business as compared to projected future operating results,
and NICs strategic refocusing on our core portal outsourcing business and away from our software & services businesses. Specifically, we
determined that the recent downturn in IDTs financial performance was expected to continue and would not be temporary, as we previously expected.
This was a reversal of IDTs historical trend of modest profitability, and was primarily attributable to government-imposed contract delays and
funding shortfalls on the part of governments with whom IDT had contracted.

Management reached the conclusion that it would not
continue to support IDTs business and decided to wind down IDTs operations. Accordingly, we concluded the remaining goodwill related to the
IDT acquisition no longer had value and recognized a $1.3 million impairment loss in the second quarter of 2002. IDT did not qualify as a discontinued
operation as of December 31, 2004.

AOL

During the second quarter of 2002, we identified
indicators of possible impairment of the cash and warrant portions of the carriage fee paid and payable to AOL pursuant the Interactive Services
Agreement between the Company and AOL. Beginning in the second quarter of 2001, our share of revenues generated from AOLs sale of advertisement
through Government Guide had increased steadily on a sequential quarterly basis. However, in the second quarter of 2002, revenues from our AOL business
decreased precipitously as compared to recent quarters. This was primarily a result of lower AOL Government Guide advertising revenues due to weakness
in the overall advertising market in general and the online advertising market in particular. This drop in advertising revenues was in contrast to the
growth in revenues our AOL business had experienced historically. Additionally, based on discussions with AOL personnel at the time, we did not expect
our AOL business to achieve revenue growth consistent with the growth it had experienced historically. AOL had specifically noted in their filings with
the SEC at the time that they expected the weakness in the online advertising market to continue for the foreseeable future. Accordingly, we reduced
the revenue forecast for our AOL business for the remainder of 2002 and through the completion of our contract with AOL.

Management determined that the expected future cash
flows of its AOL business would not be sufficient to recover the cash carriage fee we would have recognized over the remaining term of the contract
with AOL. Through the second quarter of 2002, we had made cash payments to AOL totaling approximately $2.3 million, with approximately $500,000
recorded as a prepaid expense at June 30, 2002, and had to pay the remaining $412,500 in a series of three quarterly installments ending in March 2003.
Additionally, management determined the future cash flows of this business would not be sufficient to recover the unamortized carrying amount of the
fully vested warrants issued to AOL, which totaled approximately $2.1 million at June 30, 2002. The carrying amount of the fully vested warrants was
previously recorded as an intangible asset in the consolidated balance sheet. As a result, we recognized a $3.0 million impairment loss in the second
quarter of 2002.

32

Financial Analysis of Years Ended December 31, 2004, 2003 and
2002

In this section, we are providing more detailed
information about our operating results and changes in financial position over the past three years. This section should be read in conjunction with
the consolidated financial statements and related notes included in this Form 10-K.

Key Financial Metrics

2004

2003

2002

Revenue
growth  outsourced portals

21

%

16

%

32

%

Same state
revenue growth  outsourced portals

20

%

7

%

15

%

Revenue
growth  software & services

(32

%)

(17

%)

20

%

Gross profit
%  outsourced portals

49

%

46

%

43

%

Gross profit
%  software & services

23

%

21

%

(7

%)

Selling &
administrative as % of revenue

22

%

23

%

28

%

Operating
income margin %

21

%

14

%

(17

%)

PORTAL REVENUES. In the analysis below, we have
categorized our portal revenues according to the underlying source of revenue (in thousands), with the corresponding percentage increase or decrease
from the prior year period.

Portal Revenue Analysis

2004

Increase/(Decrease)
from 2003

2003

Increase/(Decrease)
from 2002

2002

DMV
transaction-based

$

30,498

22

%

$

25,088

13

%

$

22,253

Non-DMV
transaction-based

14,656

35

%

10,846

34

%

8,065

Portal
management

360

(70

%)

1,200

(6

%)

1,274

Software
development

3,030

(1

%)

3,075

(4

%)

3,187

Total

$

48,544

21

%

$

40,209

16

%

$

34,779

Portal revenues for 2004
increased 21%, or approximately $8.3 million, over 2003. Of this increase, 17%, or approximately $6.9 million, was attributable to an increase in same
state portal revenues (states in operation and generating DMV revenues for two full years) and 6%, or approximately $2.5 million, was attributable to
our newer portals including Kentucky ($2.1 million), which began to generate DMV revenues in September 2003, and Alabama ($0.5 million), which began to
generate DMV revenues in February 2003. These increases were partially offset by a decrease in revenues from our local portals, primarily due to the
continued wind down of certain of our unprofitable local portal businesses. In 2004, the Company ceased providing local portal services to Dallas
County, Texas, the City of Corpus Christi, Texas, and Washtenaw County, Michigan. Same state portal revenues in 2004 increased 20% over 2003 primarily
as a result of increased transaction revenues from several of our portals, most notably Hawaii, Montana, Tennessee and Utah. Our same state revenue
growth in 2004 was higher than the 7% growth we achieved in 2003 due in part to a 14% increase (approximately $3.2 million) in same state DMV
transaction-based revenues. This increase was mainly attributable to modest DMV price increases in two portal states in late 2003 and in one portal
state in late 2004. In addition, same state non-DMV transaction based revenues increased 39%, or approximately $3.9 million, in 2004 due primarily to
the addition of several new revenue generating applications in existing portals.

Portal revenues for 2003 increased 16%, or
approximately $5.4 million, over 2002. Of this increase, 10%, or approximately $3.4 million, was attributable to our newer outsourced state portal
businesses including Alabama ($2.2 million) and Kentucky ($0.8 million), and 6%, or approximately $2.2 million, was attributable to an increase in same
state portal revenues. Same state portal revenues in 2003 increased 7% over 2002 primarily as a result of increased transaction volumes from our Iowa,
Indiana, Utah and Maine portals. Our Iowa portal began to generate DMV revenues beginning in January 2003 as a result of a new contract with the state
of Iowa. Our Iowa portal business did have a contract that provided recurring annual revenues prior to 2003 in the form of fees paid by the state to
NIC for the operation of the states portal. The contract was expanded in 2003 to add the DMV application, which enabled the portal to become
self-funded like the majority of our other state portal businesses. The increase

33

in revenues from our Indiana, Maine and Utah
portals was the result of the addition of several new non-DMV applications during the year. Our same state revenue growth in 2003 was less than the
growth we had achieved in recent years due primarily to a 1% year-over-year decrease in same state DMV revenues. While we generally expect same state
DMV revenues to grow only 1% to 3% per year, we experienced a large increase in same state DMV revenues in 2002 due in part to more robust U.S.
automobile sales than in 2003. Same state non-DMV transaction-based revenues increased 35%, or approximately $2.5 million, in 2003 due primarily to the
addition of new revenue generating applications in existing portals.

COST OF PORTAL REVENUES. Cost of portal revenues in
2004 increased 15%, or approximately $3.3 million, over 2003. Of this increase, 15%, or approximately $3.1 million, was attributable to an increase in
same state cost of portal revenues, and 4%, or approximately $0.8 million, was attributable to our newer state portal businesses, including Kentucky
and Alabama. These increases were offset by a $0.7 million decrease in operating expenses from our local portals as a result of the continued wind down
of certain of our unprofitable local portal businesses. Same state cost of portal revenues in 2004 increased 18%, or approximately $3.1 million,
primarily as a result of the addition of personnel in several of our portals due to our continued growth and reinvestment in our core business. Also
contributing to the increase in same state cost of portal revenues was an increase in merchant bank fees. A growing percentage of our non-DMV revenues
are generated from online applications whereby users pay for information or transactions via credit cards. We typically earn a percentage of the credit
card transaction amount, but also must pay an associated fee to the merchant bank that processes the credit card transaction. We earn a lower gross
profit percentage on these transactions as compared to our other non-DMV applications. However, we anticipate these revenues and the associated
merchant card fees to continue to increase in the future, as these transactions contribute favorably to our operating income growth.

Our portal gross profit rate increased to 49% in
2004 from 46% in 2003. This increase was primarily attributable to a full year of operations in 2004 from our Kentucky portal, and to a modest
improvement in our same state gross profit rate. On a same state basis, our portal gross profit rate was 50%, an increase of less than 1% from 2003.
While same state portal revenues grew by 20% in 2004, same state cost of portal revenues increased by approximately 18%, as further discussed above. We
are generally able to increase our same state portal gross profit rate by increasing business and citizen adoption of existing portal applications and
building new non-DMV revenue generating applications and services within existing portals while growing portal operating expenses at a rate
considerably less than portal revenue growth. We intend to continue to expand our portal operations by developing and promoting new non-DMV
applications and services within our existing portals. Accordingly, we expect our same state gross profit rate to continue to increase modestly in the
foreseeable future.

Cost of portal revenues in 2003 increased 9%, or
approximately $1.7 million, over 2002. Of this increase, 7%, or approximately $1.4 million, was attributable to our newer state portal businesses,
including Alabama and Kentucky, and 5%, or approximately $0.9 million, was attributable to a modest increase in same state cost of portal revenues.
These increases were partially offset by a $0.6 million decrease in operating expenses from our local portals as a result of our cost reduction efforts
in certain of our local portals to improve their profitability.

Our portal gross profit rate increased to 46% in
2003 from 43% in 2002. This increase was primarily attributable to a full year of operations in 2003 from our Alabama portal, and to an improvement in
our local portal gross profit rate as a result of cost reduction efforts in certain of our local portals to improve their profitability. Our same state
portal gross profit rate increased less than 1% in 2003 due primarily to lower same state revenue growth in 2003 as further discussed
above.

34

SOFTWARE & SERVICES REVENUES. In the analysis
below, we have categorized our software & services revenues by business (in thousands), with the corresponding percentage increase or decrease from
the prior year period.

Software & Services Revenue Analysis

2004

Increase/(Decrease)
from 2003

2003

Increase/(Decrease)
from 2002

2002

Corporate
Filings  California Secretary of State

$

4,074

(44%)

$

7,225

2%

$

7,079

Corporate
Filings  Legacy contracts

190

(20%)

238

(73%)

883

Ethics &
Elections

2,247

(5%)

2,361

15%

2,058

Transportation

427

(12%)

485

(60%)

1,216

AOL

160

14%

140

(91%)

1,482

Other

120

(31%)

173

260%

48

Total

$

7,218

(32%)

$

10,622

(17%)

$

12,766

Software & services revenues in 2004 decreased
32%, or approximately $3.4 million, from 2003 primarily due to a decrease in revenues from our corporate filings business. We recognized approximately
$4.1 million in revenue from our contract with the California Secretary of State in the current year compared to $7.2 million the prior year. We
recognize revenues and profit on our contract with the California Secretary of State using the percentage of completion method as we make progress,
utilizing costs incurred to date as compared to the estimated total cost for the contract.

Software & services revenues in 2003 decreased
17%, or approximately $2.1 million, from 2002 primarily as a result of a broad strategic refocusing in mid-2002 on our profitable core outsourced
portal business and a de-emphasis of certain of our acquired software & services businesses, including our eProcurement, transportation and AOL
businesses, as further discussed above. Revenues from our AOL business decreased by approximately $1.3 million to less than $0.2 million in 2003. As
previously disclosed, and as further discussed above, we experienced a significant decrease in revenues from our AOL business in 2003 as compared to
prior periods due to continued weakness in the online advertising market. In addition, revenues from our transportation business, IDT, decreased by
approximately $0.7 million to $0.5 million in 2003. As previously disclosed, we decided to wind down this business in 2002. Total corporate filings
revenues decreased by $0.5 million to $7.5 million in 2003. We recognized approximately $7.2 million in revenue from our contract with the California
Secretary of State in 2003 compared to $7.1 million in 2002. Revenues from legacy corporate filing contracts, primarily relating to Arkansas and
Oklahoma, decreased by $0.6 million to $0.2 million in 2003. Revenues from our ethics & elections business increased by approximately $0.3 million
to $2.4 million in 2003 as a result of additional work performed under its contract with the Federal Election Commission.

COST OF SOFTWARE & SERVICES REVENUES. The
decrease in cost of software & services revenues in 2004 was mostly due to a decrease in project costs incurred on our contract with the California
Secretary of State, and was relatively consistent with the corresponding decrease in project revenues as further discussed above. In addition, in the
third quarter of 2004, we reversed approximately $0.4 million in loss accruals relating to our legacy business filing contracts in Arkansas and
Oklahoma, as these contracts are expected to cost less to complete than our previous estimates (for further discussion, see Note 2 in the Notes to
Consolidated Financial Statements included in this Form 10-K). This adjustment positively affected our software & services gross profit rate for
2004. Additionally, in the first quarter of 2004, we reduced our expected profit margin on our contract with the California Secretary of State from
approximately 6% to 4% due to an increase in estimated costs to complete the contract as a result of adding project management resources to the
project. This margin adjustment adversely affected our software & services gross profit rate for 2004.

Cost of software & services revenues in 2003
decreased 38%, or approximately $5.2 million, from 2002. Cost of software & services revenues for 2002 includes a net charge of $3.5 million for
anticipated costs in excess of revenues to be recognized under certain of our application development contracts in our corporate filings business (see
Note 2 in the Notes to Consolidated Financial Statements included in this Form 10-K). Also contributing to

35

the decrease in expenses in 2003 was a $0.7
million decrease relating to our AOL business and a $0.5 million decrease relating to our transportation business. As previously disclosed, in the
second quarter 2002, we determined that the expected future cash flows of our AOL business would not be sufficient to recover the cash carriage fee and
common stock warrant amortization expense we would have recognized over the remaining term of the contract with AOL and recorded a $3.0 million
impairment loss. As a result, the Company no longer recorded the cash portion of the carriage fee expense in cost of software & services revenues,
which approximated $0.3 million in 2002. In addition, we significantly reduced the number of dedicated employees related to AOL and, as a result,
reduced employee payroll costs by approximately $0.2 million in 2003.

SELLING & ADMINISTRATIVE. Selling &
administrative expenses in 2004 increased 3%, or approximately $0.3 million, from 2003, as a result of a modest increase in costs for new business
development initiatives. Selling & administrative expenses in 2003 decreased 12%, or approximately $1.6 million, from 2002. The majority of this
decrease was a reduction in expenses from our software & services businesses resulting from our restructuring and cost containment efforts. Selling
& administrative expenses as a percentage of revenue were 22%, 23%, and 28% for 2004, 2003 and 2002, respectively. We expect selling &
administrative costs as a percentage of revenues to continue to decline as our revenues grow and our corporate expenses remain relatively flat year
over year.

IMPAIRMENT LOSS. For additional information on the
impairment losses we recorded in 2002, refer to the discussion above under Software & Services Businesses  Discontinued Operations and
Impairment Losses and in Note 4 in the Notes to Consolidated Financial Statements included in this Form 10-K.

STOCK COMPENSATION. Stock compensation for 2002
consisted primarily of amortization of deferred compensation expense related to common stock options granted to senior level executives and other key
employees in 1999 and 1998. By the end of the second quarter of 2002, all deferred compensation expense relating to options granted in 1999 and 1998
had been recognized.

DEPRECIATION & AMORTIZATION. Depreciation &
amortization expense decreased in 2004 as certain capital expenditures made after our initial public offering in 1999 have become fully depreciated.
Depreciation & amortization expense decreased in 2003 by approximately $1.2 million from 2002. As further discussed above, in the second quarter of
2002, we determined the future cash flows of our AOL business would not be sufficient to recover the unamortized carrying amount of the fully vested
warrants issued to AOL and recorded a $2.1 million impairment loss in the second quarter of 2002. As a result, we no longer recorded amortization
expense relating to these warrants. We recognized approximately $0.7 million in warrant amortization expense in 2002. Depreciation expense decreased by
approximately $0.5 million in 2003 as certain capital expenditures made after our initial public offering in 1999 have become fully depreciated. We
expect depreciation expense for 2005 to range from $1.6 to $1.8 million. We do not expect to incur amortization expense in 2005.

EQUITY IN NET LOSS OF AFFILIATES. Equity in net loss
of affiliates represents our share of losses of companies in which we have had equity method investments that give us the ability to exercise
significant influence, but not control, over the investees. In the first quarter of 2000, we invested in two private companies involved in the
eGovernment services industry, Tidemark and E-Filing, primarily for strategic purposes. In the fourth quarter of 2000, we invested in eGS, a private
joint venture among Swiss venture capital firm ETF Group, London-based venture development organization Vesta Group, and our European subsidiary, NIC
European Business Ltd. In May 2001, a private technology company acquired Tidemark. We recognized a $0.3 million gain in the second quarter of 2003
relating to our previous equity investment in Tidemark. In May 2004, E-Filing repurchased the Companys ownership interest in E-Filing for
$535,000, which approximated the carrying value of the Companys investment at the date of the repurchase. The Company had no investment balance
remaining in E-Filing after the repurchase. As a result of a modification to the eGS joint venture agreement, the Company has accounted for its
investment in eGS under the cost method beginning in fiscal 2003. At December 31, 2004, we held no investments in affiliates or joint ventures
accounted under the equity method. See Note 6.

INCOME TAXES. We recognized income tax expense in
2004 and 2003 and an income tax benefit in 2002. Our effective tax rate was approximately 40% in 2004, 16% in 2003 and 39% in 2002. Our income tax
provision in 2003 was less than the amount customarily expected due primarily to deferred tax asset adjustments recorded

36

in the fourth quarter of 2003 totaling a benefit
of approximately $1.8 million as more fully described in Note 10 to the Notes to Consolidated Financial Statements included in this Form 10-K.
Prospectively, we expect our effective tax rate to be approximately 40%.

Liquidity and Capital Resources

Net cash provided by operating activities was $14.6
million in 2004 compared to $3.5 million in 2003. This improvement was primarily the result of approximately $6.6 million in milestone payments
received from the California Secretary of State and a year-over-year improvement in our operating income, excluding non-cash charges. These payments
from the California Secretary of State contributed to the decrease in unbilled revenues in the current year. We have been recognizing revenues on this
contract under percentage of completion accounting as progress is made on the project. However, we do not receive regular progress payments from the
California Secretary of State, which contributes to fairly significant fluctuations in unbilled revenues each reporting period. The increase in accrued
expenses in the current year was partially due to accrued subcontractor costs on this project, as we are not required to pay certain subcontractors
until we receive major milestone payments under the contract. Approximately $1.0 million of the milestone payments received in 2004 were paid to
certain subcontractors during the year. We are scheduled to receive two additional milestone payments of approximately $3.3 million each in the future,
currently estimated to be over the course of the next 12 to 15 months. The first payment will be for the delivery of the business entity filing system
into acceptance testing. The second payment will be for the acceptance of the business entity filing system by the Secretary of State and commencement
of the associated maintenance period. The decrease in accounts payable in 2004 was mainly attributable to the continued wind down of certain of our
unprofitable local portal businesses during the year, as further discussed above.

Net cash provided by operating activities was $3.5
million in 2003 compared to net cash used of $6.5 million in 2002. This improvement was primarily the result of a year-over-year improvement in
operating income, excluding non-cash charges, that was partially offset by a negative net change in operating assets and liabilities as compared to the
prior year. The primary contributor to this negative net change was an increase in unbilled revenues on our corporate filings contract with the
California Secretary of State. The increase in accrued expenses in 2003 was partially due to accrued subcontractor costs on this project. The increases
in accounts receivable and accounts payable in 2003 were mainly attributable to an increase in revenues from our portal businesses in Alabama and
Kentucky, which began to generate DMV revenues in 2003 (a $1.6 million increase in accounts receivable), and to an increase in fourth quarter tax
receipts from tax filing applications in Hawaii, Indiana and Dallas County (a $2 million increase in accounts receivable). The majority of these tax
receipts were remitted to our government partners in January 2004.

We recognize revenue from providing outsourced
government portal services net of the transaction fees due to the government when the services are provided. The fees that the Company must remit to
the government are accrued as accounts payable and accounts receivable at the time services are provided. As a result, trade accounts receivable and
accounts payable reflect the gross amounts outstanding at the balance sheet dates. Gross billings for the years ended December 31, 2004 and 2003 were
approximately $197.7 million and $177.7 million, respectively. The Company calculates days sales outstanding by dividing trade accounts receivable at
the balance sheet date by gross billings for the period and multiplying the resulting quotient by the number of days in that period. Days sales
outstanding for the years ended December 31, 2004 and 2003 was 33 and 37, respectively.

We believe that working capital is an important
measure of our short-term liquidity. Working capital, defined as current assets minus current liabilities, increased to $35.7 million at December 31,
2004 from $24.6 million at December 31, 2003. Our current ratio, defined as current assets divided by current liabilities, at December 31, 2004 was 2.7
compared to 2.1 at December 31, 2003. The increase in both of these measures was primarily attributable to an increase in total cash and cash
equivalents as a result of the significant increase in our operating cash flow in 2004.

Investing activities in 2004 resulted in net cash
used of $0.6 million, reflecting $1.2 million in capital expenditures, which were partially offset by the maturity of marketable securities (as further
discussed in Note 7

37

in the Notes to Consolidated Financial
Statements included in this Form 10-K) and proceeds from the sale of our minority investment in E-Filing (as further discussed in Note 6 in the Notes
to Consolidated Financial Statements included in this Form 10-K). Capital expenditures in the current year were mainly attributable to computer
equipment purchases relating to our move to a new data center for company-wide hosting and disaster recovery purposes, in addition to normal fixed
asset additions in our portal business.

Investing activities in 2003 resulted in net cash
used of $1.5 million for capital expenditures, which were primarily for normal fixed asset additions in our outsourced portal business, including Web
servers, purchased software and office furniture and equipment.

Investing activities resulted in net cash generated
of $2.7 million in 2002, reflecting $3.8 million in net maturities of our marketable securities used for funding operations and for collateral
purposes. In conjunction with our contract with the California Secretary of State, in March 2002, we issued a $5 million letter of credit as collateral
for a performance bond required by the contract. The letter of credit was fully collateralized by cash at the time of issuance. Investing activities in
2002 also reflect approximately $1 million of capital expenditures and $0.2 million in contributions to the eGS joint venture.

Financing activities in 2004 resulted in net cash
generated of approximately $3.3 million, reflecting a $2.4 million reduction in our cash collateral requirements under the financing arrangement that
covers all of the Companys outstanding letters of credit, term note payable, which was paid off in 2004, and working capital line of credit (as
further discussed in Note 7 in the Notes to Consolidated Financial Statements included in this Form 10-K). Financing activities in 2004 also reflect
$1.3 million in proceeds from the exercise of employee stock options and our employee stock purchase program. Although we cannot predict the annual
amount of proceeds we expect to receive from employee stock options in the future, we expect that our employees will continue to exercise vested stock
options that have intrinsic value. At December 31, 2004, approximately 2.2 million employee stock options were exercisable at a weighted average
exercise price of $3.76 per share. The closing price of our common stock on December 31, 2004 was $5.08 per share.

Net cash provided by financing activities totaled
approximately $2.0 million in 2003, primarily reflecting a $0.9 million decrease in restricted cash to collateralize our bank note payable and certain
bank letters of credit issued on behalf of the Company, and $0.2 million in payments on our note payable. We received approximately $1.2 million in
proceeds from the exercise of employee stock options and our employee stock purchase program.

Net cash used in financing activities totaled
approximately $3.9 million in 2002, primarily reflecting a $6.3 million increase in restricted cash to collateralize our bank note payable and certain
bank letters of credit issued on behalf of the Company, and $0.2 million in payments to repurchase common stock from a former executive of the Company.
We received approximately $3.0 million in proceeds in 2002 from the exercise of employee stock options, the majority of which came from a former
executive of the Company, and from our employee stock purchase program.

At December 31, 2004, our total unrestricted cash
balance was $30.8 million compared to $13.5 million at December 31, 2003. At December 31, 2004, we had posted $3.0 million in cash as collateral for
bank letters of credit issued on behalf of the Company. We issue letters of credit as collateral for performance on certain of our government contracts
and as collateral for certain performance bonds. These irrevocable letters of credit are generally in force for one year. We expect our collateral
requirements to continue to ease over time as we continue to produce consecutive quarters of profitability and earnings growth. However, even though we
expect to be profitable in 2005 and beyond, we may not be able to sustain our current levels of profitability or increase profitability on a quarterly
or annual basis. We will need to generate sufficiently higher revenues while containing costs and operating expenses if we are to achieve growing
profitability. We cannot be certain that our revenues will continue to grow or that we will ever achieve sufficient revenues to become profitable on a
long-term, sustained basis. If we are not able to sustain profitability, our cash collateral requirements may increase. Had the Company been required
to post 100% cash collateral at December 31, 2004 for the face value of all performance bonds (which are partially supported by letters of credit) and
our line of credit in conjunction with a corporate credit card agreement, unrestricted cash would have decreased and restricted cash would have
increased by approximately $4.8 million.

38

We believe that our currently available liquid
resources and cash generated from operations will be sufficient to meet our operating requirements, capital expenditure requirements, and current
growth initiatives for at least the next twelve months without the need of additional capital. However, we may need to raise additional capital before
this period ends to further:



fund operations, including the costs to fund our contract with
the California Secretary of State and subcontractors on that project;



collateralize letters of credit, which we are required to post
as collateral for performance on certain of our outsourced government portal contracts and as collateral for certain performance bonds;



support our expansion into other states and government agencies
beyond what is contemplated in 2005 if unforeseen opportunities arise;



expand our product and service offerings beyond what is
contemplated in 2005 if unforeseen opportunities arise;



respond to unforeseen competitive pressures; and



acquire complementary technologies beyond what is contemplated
in 2005 if unforeseen opportunities arise.

Any projections of future earnings and cash flows
are subject to substantial uncertainty. If our unrestricted cash and cash generated from operations are insufficient to satisfy our liquidity
requirements, we may seek to sell additional equity securities, issue debt securities, or increase our working capital line of credit. The sale of
additional equity securities could result in dilution to the Companys shareholders. There can be no assurance that financing will be available in
amounts or on terms acceptable to the Company, if at all.

At December 31, 2004, we were bound by performance
bond commitments totaling approximately $7.3 million on certain government contracts. Of this amount, $5 million relates to the performance bond
requirement on our contract with the California Secretary of State, which is collateralized by a $5 million letter of credit. Upon acceptance of the
business entity filing system and commencement of the associated maintenance period, which we currently expect to take place within the next 12 to 15
months, the Company will no longer be required to provide a performance bond under this contract. We have never had any defaults resulting in draws on
performance bonds.

We do not have off-balance sheet arrangements or
significant exposures to liabilities that are not recorded or disclosed in our financial statements. While we have significant operating lease
commitments for office space, those commitments are generally tied to the period of performance under related contracts. The following table sets forth
our future contractual obligations and commercial commitments as of December 31, 2004 (in thousands):

Contractual Obligations

Total

Less than
1 year

13 years

35 years

More than
5 years

Operating
lease obligations

$

2,761

$

1,305

$

1,302

$

154

$



Long-term
debt obligations











Capital lease
obligations











Purchase
obligations











Other
long-term liabilities











Total
contractual cash obligations

$

2,761

$

1,305

$

1,302

$

154

$



39

Deferred Tax Assets

At December 31, 2004, we have recorded net deferred
tax assets in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, totaling approximately
$31.7 million. We estimate that we must generate at least $78.3 million of future taxable income to realize those deferred tax assets. To achieve a
sufficient level of future taxable income, we intend to continue to pursue our current strategy of adding new government partners, broadening our
service offerings in our existing government portals, and increasing transactional revenues from our existing government portals. Based on information
currently known to management, we believe it is more likely than not that the Company will realize the deferred tax assets. The table below reconciles
income (loss) from continuing operations before income taxes for financial statement purposes with taxable income (loss) before net operating loss
carryforwards for federal income tax purposes (in thousands):

Year ended December 31,

2004

2003

2002

Income (loss)
from continuing operations before income taxes

$

11,810

$

7,513

$

(9,107

)

Loss before
income taxes  discontinued operations





(3,342

)

Amortization
of purchase accounting intangibles

(2,245

)

(2,245

)

(1,899

)

Net operating
loss relating to NIC Conquest





1,820

Impairment of
intangible assets



(2,083

)

4,316

Equity in net
loss of affiliates

106

195

1,235

Accrued
expenses

1,100

2,775



Deductions
relating to stock options

(1,741

)

(1,382

)

(535

)

Stock
compensation expense





1,307

Provision for
loss on application development contracts



(1,230

)

(2,403

)

Depreciation
and capitalized software amortization

(243

)

(277

)

(139

)

Gain/(loss)
on disposition of assets and equity investments

589

(715

)



Other

235

77

326

Taxable
income (loss)  2004 is an estimate

$

9,611

$

2,628

$

(8,421

)

The taxable income (loss) for federal income tax
purposes includes deductible temporary differences. As of December 31, 2004, our net deductible temporary differences, exclusive of net operating loss
carryforwards, total approximately $36.8 million. Our federal income tax loss carryforward of approximately $59.4 million expires as follows: $22.0
million expires in 2020, $27.1 million expires in 2021 and $10.3 million expires in 2022. Our state income tax loss carryforwards of approximately
$60.0 million may be used over various periods ranging from 1 to 19 years. We are currently paying state income taxes in certain
states.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards (SFAS) No. 123R (revised 2004), Share-Based Payment, that requires
companies to expense the grant-date fair value of stock options and other equity-based compensation issued to employees. SFAS No. 123R eliminates the
use of the intrinsic value method prescribed in ABP No. 25 that we currently use to account for our stock-based compensation plans. SFAS No. 123R is
effective for interim and annual periods beginning after June 15, 2005. We will be required to adopt SFAS No. 123R in the third quarter of 2005. We
currently expect to use the modified prospective transition method, which would not require us to restate our financial statements prior to the
effective date of SFAS No. 123R. For vested stock option awards that are outstanding on the effective date of SFAS No. 123R, the modified prospective
method would not require us to record any additional compensation expense. For unvested stock option awards that are outstanding on the effective date,
awards that were previously included as part of the pro forma net income (loss) and earnings (loss) per share calculations of SFAS No. 123 would be
charged to expense over the remaining vesting period, without any changes in measurement. For all new stock option awards that are granted or modified
after the effective date, we would use SFAS No. 123Rs measurement model, expense recognition, and settlement provisions. Based on the expected
remaining unrecognized fair value of stock

40

option awards we estimated for purposes of
preparing our current SFAS No. 123 pro forma disclosures (see Note 2 in the Notes to Consolidated Financial Statements including in this Form 10-K),
the effect of adopting SFAS No. 123R in 2005 on net income is expected to be approximately $0.4 million, or approximately $0.01 per
share.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK

INTEREST RATE RISK. Our exposure to market risk for
changes in interest rates relates to the increase or decrease in the amount of interest income we can earn on cash balances. We limit our exposure to
credit loss by depositing our cash and cash equivalents with high credit quality financial institutions. We ensure the safety and preservation of our
invested principal funds by limiting default risk, market risk and investment risk. We do not use derivative financial instruments. A 10% change in
interest rates would not have a material effect on our financial condition, results of operations or cash flows.

Changes in
operating assets and liabilities, net of effects
of acquisitions:

(Increase)
decrease in trade accounts receivable

(2,634,198

)

(3,406,392

)

261,348

(Increase)
decrease in unbilled revenues

(463,890

)

(5,660,799

)

2,598,668

(Increase)
decrease in prepaid expenses &
other current assets

(80,161

)

103,991

43,672

Decrease in
other assets

109,829

29,442

23,313

Increase
(decrease) in accounts payable

1,469,370

3,594,759

(1,951,482

)

Increase
(decrease) in accrued expenses

(1,701,553

)

1,419,608

1,020,798

(Decrease) in
other current liabilities

(95,562

)

(355,144

)

(7,060

)

Net cash
provided by (used in) operating activities

(6,451,606

)

3,497,390

14,564,462

Cash flows
from investing activities:

Purchases of
property and equipment

(967,627

)

(1,518,798

)

(1,189,336

)

Purchases of
marketable securities

(23,745,011

)

(497,705

)



Maturities of
marketable securities

27,566,194

500,000

250,000

Proceeds from
sale of affiliate





300,005

Investments
in affiliates and joint ventures

(191,000

)





Net cash
provided by (used in) investing activities

2,662,556

(1,516,503

)

(639,331

)

45

Year Ended December 31,

2002

2003

2004

Cash flows
from financing activities:

Cash and cash
equivalents  restricted

$

(6,300,054

)

$

937,021

$

2,363,033

Payments on
notes and debentures payable

(339,833

)

(169,877

)

(363,033

)

Payments on
capital lease obligations

(13,762

)





Payments to
repurchase common stock

(215,260

)





Proceeds from
employee common stock purchases

84,611

72,487

116,746

Proceeds from
exercise of employee stock options

2,881,682

1,160,796

1,186,391

Proceeds from
stock subscriptions receivable

15,000





Net cash
provided by (used in) financing activities

(3,887,616

)

2,000,427

3,303,137

Net increase
(decrease) in cash and cash equivalents

(7,676,666

)

3,981,314

17,228,268

Cash and cash
equivalents, beginning of year

17,235,752

9,559,086

13,540,400

Cash and cash
equivalents, end of year

$

9,559,086

$

13,540,400

$

30,768,668

Other cash
flow information:

Interest
paid

$

49,193

$

20,927

$

10,852

Income taxes
paid

$

94,200

$

382,358

$

465,172

The accompanying notes are an integral part of these consolidated financial
statements.

46

NIC INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.

THE COMPANY AND BASIS OF PRESENTATION

The Company

NIC Inc., formerly National Information Consortium,
Inc. (the Company or NIC), provides federal, state and local governments with a wide range of eGovernment services, including a
broad range of software and applications. NIC helps governments use the Internet by building Web sites and applications that allow businesses and
citizens to access government information and complete government-based transactions online. Some examples of applications include: professional
license renewals, Internet tax filings, drivers license and motor vehicle record searches, automated Uniform Commercial Code (UCC)
file searches and automobile registration renewals. The Companys primary business activity is to design, build and operate Internet-based portals
on behalf of state governments desiring to provide access to government information and to complete government-based transactions online. Operating
under multiple-year contracts (see Note 3), NIC markets the services and solicits users to complete government-based transactions and to enter into
subscriber contracts permitting users to access the portal and the government information contained therein in exchange for transactional and/or
subscription user fees. The Company is typically responsible for funding up front investment and ongoing operational costs of the outsourced government
portals. In July 1999, the Company completed its initial public offering of common stock.

In September 1999, NIC acquired the net assets of
eFed, a provider of Internet-based procurement software and services for governments. eFed was renamed NIC Commerce and is wholly owned by NIC. In the
second quarter of 2002, the Company exited its domestic eProcurement business entirely, and has classified the results of operations of NIC Commerce as
discontinued operations. In January 2000, NIC merged its application services division with Conquest Softworks, LLC (Conquest) and renamed
the company NIC Conquest. NIC Conquest, a wholly owned subsidiary of NIC and the Companys corporate filings business, is a provider of UCC and
corporation software applications and services that facilitate electronic filings and document management for secretaries of state. At December 31,
2004, NIC Conquest was primarily engaged in servicing its contract with the California Secretary of State (see Note 2). In May 2000, NIC acquired SDR
Technologies, Inc. (SDR), a provider of Internet-based applications for governments. SDR was renamed NIC Technologies and is wholly owned
by NIC. NIC Technologies, the Companys ethics & elections business, designs and develops online election and ethics filing systems for
federal and state government agencies. At December 31, 2004, NIC Technologies was primarily engaged in servicing its contracts with the Federal
Election Commission and the state of Michigan. In October 2000, NIC acquired Intelligent Decision Technologies, Ltd. (IDT), a provider of
business-to-government reporting and filing software for the transportation industry. In the second quarter of 2002, the Company decided to wind down
substantially all of IDTs operations. As of December 31, 2004, the IDT business did not qualify as a discontinued operation. All business
acquisitions in 1999 and 2000 were accounted for as purchases and the results of the acquired companies operations have been included in the
Companys consolidated statements of operations from the respective dates of acquisition. These acquired businesses comprise the Companys
software & services division, along with the AOL business. The Companys contract with AOL expired December 31, 2004. For further discussion
of the Companys software & services businesses, see Note 4.

The Company expanded rapidly following its initial
public offering in July 1999 and incurred substantial net losses through the second quarter of 2002 primarily as a result of its software &
services businesses. Throughout this time period, the Companys core outsourced portal operations have grown and have been profitable. As part of
a broad strategic refocusing of the Company on its profitable core outsourced portal business during 2002, NIC exited its eProcurement and
transportation businesses and restructured the other software & services businesses in an effort to accelerate the Companys path to
profitability. The Company became profitable in the second half of 2002 (see Note 14), and management has focused the business on operations that it
believes have demonstrable ability to produce positive net income and cash flow in the future.

47

Basis of presentation

The Company classifies its revenues and cost of
revenues into two categories: (1) portal and (2) software & services. The portal category includes revenues primarily from the Companys
subsidiaries operating government portals under long-term contracts on an outsourced basis. The software & services category includes revenues
primarily from the Companys corporate filings, ethics & elections, transportation and AOL businesses. The primary categories of operating
expenses include: cost of portal revenues, cost of software & services revenues, selling & administrative, and depreciation & amortization.
Cost of portal revenues consist of all direct costs associated with operating government portals on an outsourced basis including employee
compensation, telecommunications and all other costs associated with the provision of dedicated client service such as dedicated facilities. Cost of
software & services revenues consist of all direct project costs to provide software development and services such as employee compensation,
subcontractor labor costs, and all other direct project costs including hardware, software, materials, travel and other out-of-pocket expenses. Selling
& administrative costs consist primarily of corporate-level expenses relating to human resource management, administration, legal and finance, and
all costs of non-customer service personnel from the Companys software & services businesses, including information systems and office rent.
Selling & administrative costs also consist of corporate-level expenses for market development and public relations.

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of consolidation

The accompanying consolidated financial statements
consolidate the Company together with all of its direct and indirect wholly owned subsidiaries. All significant intercompany balances and transactions
have been eliminated.

Cash and cash equivalents

Cash and cash equivalents primarily include cash on
hand in the form of bank deposits and money market funds. For purposes of the consolidated balance sheets and consolidated statements of cash flows,
the Company considers all non-restricted highly liquid instruments purchased with an original maturity of one month or less to be cash
equivalents.

Cash and cash equivalents  restricted

Cash and cash equivalents  restricted consists
of bank deposits and money market funds that have been segregated to collateralize primarily bank letters of credit issued on behalf of the
Company.

Marketable securities

The Companys marketable securities at December
31, 2003 were classified as available-for-sale and consisted of short-term U.S. government obligations. These investments are stated at fair value with
any unrealized holding gains or losses included as a component of shareholders equity as accumulated other comprehensive income or loss until
realized. The cost of securities sold is based on the specific identification method. The fair values of the Companys marketable securities are
based on quoted market prices at the reporting date. At December 31, 2003, the Company had pledged all of its marketable securities as collateral for
its bank line of credit in conjunction with a corporate credit card agreement. At December 31, 2004, the Company is no longer required to collateralize
the line of credit. See Note 7.

Unbilled revenues

Unbilled revenues consist of revenues earned in
excess of billings under long-term application development contracts accounted for under the percentage of completion method relating to the
Companys corporate filings business and revenues earned in excess of billings relating to the Companys ethics & elections business.
Unbilled

48

revenues arise when revenues have been recorded
but the amounts cannot be billed under the terms of the contracts. Such amounts are recoverable from customers upon various measures of performance
including, among others, achievement of certain milestones and completion of services during a specified period.

At each balance sheet date, the Company makes a
determination as to the portion of the unbilled receivable relating to the Companys long-term application development contracts that will be
collected within one year and records that amount as a current asset in the consolidated balance sheets. The remainder of the receivable, if any, is
classified as a long-term asset. All unbilled revenues relating to the Companys ethics & elections business are collectible within one year
of the balance sheet dates and have been classified as a current asset.

Unbilled revenues relating to the Companys
contract with the California Secretary of State at December 31, 2003 and 2004 were approximately $8.4 million and $5.6 million. Unbilled revenues
relating to the Companys ethics & election business at December 31, 2003 and 2004 were $0 and $0.2 million, respectively.

Property and equipment

Property and equipment are carried at cost less
accumulated depreciation. Depreciation is computed using the straight-line method over estimated useful lives of 8 years for furniture and fixtures,
310 years for equipment, 35 years for purchased software and the lesser of the term of the lease or 5 years for leasehold improvements.
When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or
loss is included in results of operations for the period. The cost of maintenance and repairs is charged to expense as incurred; significant renewals
and betterments are capitalized.

The Company periodically evaluates the carrying
value of property and equipment to be held and used when events and circumstances warrant such a review. The carrying value of property and equipment
is considered impaired when the anticipated undiscounted cash flows from the asset is separately identifiable and is less than its carrying value. In
that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the asset. Fair value is determined
primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on assets to be disposed of are determined
in a similar manner, except that fair values are reduced for the cost to dispose.

The Company adopted Statement of Financial
Accounting Standards (SFAS) No. 144, Accounting for the Impairment and Disposal of Long-Lived Assets (SFAS No.
144), effective January 1, 2002. This statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets or Long-Lived
Assets to be Disposed Of, and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting Results of
Operations  Reporting the Effects of a Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, for the disposal of a segment of the business. SFAS No. 144 addresses financial accounting and reporting for the impairment of
long-lived assets, excluding goodwill and intangible assets, to be held and used or disposed of. The adoption of SFAS No. 144 did not result in any
impairment of the Companys long-lived assets in 2002.

Investments in affiliates and joint ventures

The Company has held certain investments in
affiliates and joint ventures accounted for under the equity method. The Company uses the equity method to account for equity investments in affiliates
and joint ventures when NIC management can exert significant influence, but not control, over the operations of the investee or joint venture.
Significant influence is generally deemed to exist if the Company has an ownership interest in the voting stock of the investee or joint venture of
between 20% and 50%, although other factors, such as representation on the Board of Directors, are considered in determining whether the equity method
of accounting is appropriate. The Company regularly reviews the carrying value of its equity method investments and would record impairment losses when
events and circumstances indicate that such assets are impaired. At December 31, 2004, the Company holds no investments in affiliates or joint ventures
accounted under the equity method. See Note 6.

49

Goodwill

The Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets, effective January 1, 2002. SFAS No. 142 addresses the financial accounting and reporting for goodwill and other
intangible assets acquired in a business combination after they have been initially recognized in the financial statements and eliminates amortization
of goodwill. SFAS No. 142 requires that the Company test goodwill for impairment annually or more frequently whenever events occur or circumstances
change which would more likely than not reduce the fair value of a reporting unit below its carrying amount. A reporting unit is an operating segment
or one level below an operating segment. The first step of the impairment test is to compare the estimated fair value of the reporting unit to carrying
value. If the carrying value is less than fair value, no impairment exists. If the carrying value is greater than fair value, a second step is
performed to determine the fair value of goodwill and the amount of impairment loss, if any. There was no impairment of goodwill upon adoption of SFAS
No. 142. The Company had no goodwill remaining after the IDT goodwill impairment loss recorded by the Company in 2002. See Note 4.

Software development costs and intangible assets

The Company expenses as incurred all employee costs
to start up, operate and maintain government portals on an outsourced basis as costs of performance under the contracts because, after the completion
of a defined contract term, the government entities with which the Company contracts typically receive a perpetual, royalty-free license to the
applications the Company developed. Such costs are included in cost of portal revenues in the consolidated statements of operations.

The Company accounts for the costs of developing
internal use computer software in accordance with the American Institute of Certified Public Accountants Statement of Position (SOP) 98-1
(SOP 98-1), Accounting for the Costs of Computer Software Developed or Obtained for Internal Use and Emerging Issues Task Force
(EITF) Issue 00-2, Accounting for Website Development Costs. Costs capitalized pursuant to EITF Issue 00-2 would be included as
part of the total of internal use software development costs capitalized pursuant to SOP 98-1.

The net carrying value of intangible assets at
December 31, 2003 and 2004 was not significant and was included in other long-term assets in the consolidated balance sheets. At December 31, 2004,
intangible assets consisted primarily of Company trademarks and were not subject to amortization.

At each balance sheet date, or whenever events or
changes in circumstances warrant, the Company assesses the carrying value of intangible assets for possible impairment based primarily on the ability
to recover the balances from expected future cash flows on an undiscounted basis. If the sum of the expected future cash flows on an undiscounted basis
were to be less than the carrying amount of the intangible asset, an impairment loss would be recognized for the amount by which the carrying value of
the intangible asset exceeds its estimated fair value. There is considerable management judgment necessary to determine future cash flows, and
accordingly, actual results could vary significantly from such estimates.

Revenue recognition

Portal revenues

The Company recognizes revenue from providing
outsourced government portal services (primarily transaction-based information access fees and filing fees) net of the transaction fees due to the
government when the services are provided. The fees that the Company must remit to state agencies for data access and other statutory fees are accrued
as accounts payable at the time services are provided. The Company must remit a certain amount or percentage of these fees to government agencies
regardless of whether the Company ultimately collects the fees. As a result, trade accounts receivable and accounts payable reflect the gross amounts
outstanding at the balance sheet dates.

Revenue from service contracts to provide portal
consulting, application development and management services to governments is recognized as the services are provided at rates provided for in the
contract.

50

Software & services revenues

The Companys corporate filings business
recognizes revenues from fixed-fee, long-term application development contracts on the percentage of completion method, utilizing costs incurred to
date as compared to the estimated total costs for each contract, following the guidance outlined in Alternative B as set forth in paragraph .81 of SOP
81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. The Company primarily includes internal labor
and subcontractor labor costs in actual and estimated total costs for purposes of determining the percentage of completion for each contract. The
Company also includes costs for hardware and software provided directly to the customer as part of the system and other direct project costs such as
travel in actual and estimated total costs, but does not include such costs for determining the percentage of completion for each contract. The Company
recognizes revenue and expenses for such costs with no associated profit margin. Contract revenues and estimated costs to complete are adjusted to
reflect change orders when approved by the customer and the Company regarding both scope and price. Revenues and profits from these contracts are based
on the Companys estimates to complete and are reviewed periodically, with adjustments recorded in the period in which the revisions are made. Any
anticipated contract losses are charged to operations as soon as determinable.

In the second quarter of 2002, the Company accrued
approximately $4.3 million in cost of software & services revenues for expected losses due to project cost overruns on outstanding fixed-fee
application development contracts in Arkansas, Minnesota and Oklahoma under percentage-of-completion accounting. In the fourth quarter of 2002, the
Company reversed $0.8 million of accruals recorded in the second quarter of 2002 related to its contracts in Arkansas and Oklahoma as these contracts
were expected to cost less to complete than management estimated. At December 31, 2002, the Company had fulfilled all obligations under its contract
with the state of Minnesota. In the third quarter of 2004, the Company reversed $0.4 million of accruals recorded in the second quarter of 2002 related
to its contracts in Arkansas and Oklahoma, as these contracts are expected to cost less to complete than managements previous estimates. At
December 31, 2004, the Company fulfilled all remaining obligations under its contract with the state of Oklahoma, and recently entered into a one-year
maintenance contract renewal with the state of Arkansas, which the Company believes will be profitable. At December 31, 2004, the Company no longer has
an accrual for its application development contracts, which management believes is reasonable. Because of the inherent uncertainties in estimating the
costs of completion, it is at least reasonably possible that the estimate will change in the near term.

In September 2001, NICUSA and the Companys NIC
Conquest subsidiary were awarded a five-year contract by the California Secretary of State (the California SOS or the State) to
develop and implement a comprehensive information management and filing system. The five-year contract with the Business Programs Division of the
California SOS is valued at approximately $25 million, which the Company currently believes will be profitable. The Company has considered the
significant historic costs overruns incurred on previous fixed-fee application development contracts when determining the amount of revenue and profit
to be recognized on this contract, and believes that many of the circumstances that led to those historic cost overruns do not currently exist on this
project. However, it is at least reasonably possible that the Companys costs on this contract could similarly exceed revenues in the future as a
result of unforeseen difficulties in the creation of an application called for in the contract, unforeseen challenges in ensuring compatibility with
existing systems, rising development, subcontractor and personnel costs or other reasons. If this occurs, the Companys results of operations,
financial condition and cash flows could be harmed.

Revenues are recognized on the California SOS
contract using the percentage of completion method utilizing costs incurred to date as compared to the estimated costs for the contract, as further
described above. The Company believes costs incurred are a more representative measure of project progress than either the completion of billing or
significant project milestones, as most of the significant milestone payments under this contract are concentrated toward the latter half of the
project and do not appropriately reflect project progress and project costs incurred, especially in between milestone payment dates. The contract
contains early termination clauses that give the California SOS the right to terminate early including, among others, termination for non-appropriation
of funds and termination for convenience. Such early termination clauses are generally standard in most government

51

contracts and are not unique to the
Companys contract with the California SOS. However, in the event the contract is terminated for non-appropriation of funds, the Company would be
required to take back any affected goods furnished under the contract and to relieve the California SOS of any further obligations therefore. It is the
Companys understanding that funds for the business entity portion of the project have been appropriated through the States fiscal 2005
funding year (which ends June 30, 2005), and it is currently the Companys and States expectation that funds will be appropriated for the
remainder of the project. The Company does not recognize revenues in excess of what has been appropriated for the project. If the contract is
terminated for the convenience of the State, the parties are to negotiate a settlement, which the Company believes would include billed and unbilled
receivables for goods, manufacturing materials and/or services performed or delivered under the contract.

The Companys ethics & elections and
transportation businesses recognize revenues from professional services as the services are provided. Software maintenance revenues are recognized
ratably over the term of the support contract, typically one year. The Companys ethics & elections business has entered into contracts with
the state of Michigan and the Federal Election Commission that contain general fiscal funding clauses. The Company recognizes revenue under these
contracts if the probability of cancellation is determined to be a remote contingency.

The Company recognizes its share of AOLs
advertising revenues when notified of the amount due from AOL, which is approximately one month after the advertisement is provided. See Note
4.

The Companys eProcurement business recognized
revenues from license agreements upon delivery and acceptance of the software application if there was persuasive evidence of an arrangement,
collection of the resulting receivable was probable, the fee was fixed or determinable, and there was sufficient vendor-specific objective evidence to
support allocating the total fee to all elements of these license arrangements. Where agreements provided for evaluation or customer acceptance,
revenue was recognized upon the completion of the evaluation process and acceptance of the software by the customer.

Stock-based compensation

The Company accounts for its stock-based
compensation plans, which are described more fully in Note 11, using the intrinsic value method prescribed in Accounting Principles Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employees. Accordingly, the Company records as compensation expense the amount by
which the fair value of common stock sold to employees exceeds the amount paid. Any excess of fair value of the price of the Companys common
stock over the exercise price for options granted to employees or nonemployee directors is recorded as deferred compensation expense within
shareholders equity and amortized as stock compensation expense ratably over the vesting period. The following table illustrates the effect on
net income (loss) and net earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting
for Stock-Based Compensation, to stock-based employee compensation.

Deduct: Total
stock-based employee compensation expense determined under fair value based method for all awards,
net of related tax effects

(6,229,689

)

(2,938,705

)

(1,813,608

)

Pro forma net
income (loss)

$

(12,963,516

)

$

3,389,202

$

5,291,053

Basic and
diluted net earnings (loss) per share, as reported

$

(0.13

)

$

0.11

$

0.12

Basic and
diluted net earnings (loss) per share, pro forma

$

(0.23

)

$

0.06

$

0.09

52

The fair value of each option grant was determined
using the Black-Scholes option-pricing model. The following assumptions were applied in determining pro forma compensation cost for the years ended
December 31, 2002, 2003 and 2004:

2002

2003

2004

Risk-free interest
rate

2.95

%

2.64

%

3.16

%

Expected dividend
yield

0.00

0.00

0.00

Expected option
life

3.0

years

4.0

years

4.0

years

Expected stock price
volatility

102

%

89

%

68

%

Fair value of options
granted

$

1.18

$

2.24

$

2.95

The Black-Scholes model was not developed for use in
valuing employee stock options, but was developed for use in estimating the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, it requires the use of subjective assumptions including expectations of future dividends and stock price volatility.
Such assumptions are only used for making the required fair value estimate and should not be considered as indicators of future dividend policy or
stock price appreciation. Because changes in the subjective assumptions can materially affect the fair value estimate and because employee stock
options have characteristics significantly different from those of traded options, the use of the Black-Scholes option-pricing model may not provide a
reliable estimate of the fair value of employee stock options.

For purposes of this pro forma disclosure, the
estimated fair value of options is amortized to expense over the option vesting periods. Such pro forma impact on net income (loss) and basic and
diluted net earnings (loss) per share is not necessarily indicative of future effects on net income (loss) or earnings (loss) per
share.

Income taxes

The Company, along with its wholly owned
subsidiaries, files a consolidated federal income tax return. Deferred income taxes are recognized for the tax consequences in future years of
differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end based on enacted laws and statutory
tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be realized.

Comprehensive income (loss)

The Company has no material components of other
comprehensive income or loss and, accordingly, the Companys comprehensive income (loss) is approximately the same as its net income (loss) for
all periods presented.

Earnings (loss) per share

Basic earnings (loss) per share are calculated on
the basis of the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share are calculated on the basis
of the weighted average number of common shares outstanding during the period and common stock equivalents that would arise from the exercise of
employee common stock options and common stock warrants using the treasury stock method. The following table sets forth the computation of basic and
diluted earnings per share for the years ended December 31, 2002, 2003 and 2004:

53

Year ended December 31,

2002

2003

2004

Numerator:

Income (loss) from
continuing operations

$

(5,574,530

)

$

6,327,907

$

7,104,661

Loss from discontinued
operations

(2,035,463

)





Net income
(loss)

$

(7,609,993

)

$

6,327,907

$

7,104,661

Denominator:

Weighted average shares
 basic

56,875,327

58,330,793

58,988,456

Employee common stock
options and warrants



938,498

1,888,838

Weighted average shares
 diluted

56,875,327

59,269,291

60,877,294

Basic earnings (loss)
per share:

Income (loss) from
continuing operations

$

(0.10

)

$

0.11

$

0.12

Loss from discontinued
operations

$

(0.03

)

$



$



Net income
(loss)

$

(0.13

)

$

0.11

$

0.12

Diluted earnings (loss)
per share:

Income (loss) from
continuing operations

$

(0.10

)

$

0.11

$

0.12

Loss from discontinued
operations

$

(0.03

)

$



$



Net income
(loss)

$

(0.13

)

$

0.11

$

0.12

For the year ended December 31, 2002, diluted net
loss per share is the same as basic net loss per share because common stock issuable upon exercise of employee stock options and common stock warrants
is antidilutive. Outstanding employee common stock options totaling 1.8 million common shares and outstanding common stock warrants issued to AOL
totaling 0.6 million common shares during the year ended December 31, 2003, were not included in the computation of diluted weighted average shares
outstanding because their exercise prices were in excess of the average stock price of the Company during the period. Outstanding employee common stock
options totaling 0.7 million common shares during the year ended December 31, 2004, were not included in the computation of diluted weighted average
shares outstanding because their exercise prices were in excess of the average stock price of the Company during the period.

Concentration of credit risk

Financial instruments that potentially subject the
Company to significant concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. The Company limits its
exposure to credit loss by depositing its cash and cash equivalents with high credit quality financial institutions. The Company performs ongoing
credit evaluations of its customers and generally requires no collateral to secure accounts receivable. Due to the high credit worthiness of the
Companys customers, consisting mainly of data resellers, insurance companies and governmental entities, the Company considers accounts receivable
to be fully collectible. Accordingly, no allowance for doubtful accounts has been recorded. The Companys continuing operations have not
experienced any significant credit losses.

Segment reporting

The Company reports segment information in
accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 uses the
management approach, which designates the internal organization that is used by management for making operating decisions and assessing
performance as the source of the Companys segments. SFAS No. 131 also requires disclosures about products and services and major customers. See
Note 13.

54

Use of estimates

The preparation of financial statements in
conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those estimates.

Reclassifications

Certain prior year amounts have been reclassified to
conform to the current year presentation.

Recent accounting pronouncements

In December 2004, the Financial Accounting Standards
Board issued SFAS No. 123R (revised 2004), Share-Based Payment, that requires companies to expense the grant-date fair value of stock
options and other equity-based compensation issued to employees. SFAS No. 123R eliminates the use of the intrinsic value method prescribed in ABP No.
25 that the Company currently uses to account for its stock-based compensation plans. SFAS No. 123R is effective for interim and annual periods
beginning after June 15, 2005. The Company will be required to adopt SFAS No. 123R in the third quarter of 2005. The Company currently expects to use
the modified prospective transition method, which would not require the Company to restate its financial statements prior to the effective date of SFAS
No. 123R. For vested stock option awards that are outstanding on the effective date of SFAS No. 123R, the modified prospective method would not require
the Company to record any additional compensation expense. For unvested stock option awards that are outstanding on the effective date, awards that
were previously included as part of the pro forma net income (loss) and earnings (loss) per share calculations of SFAS No. 123 would be charged to
expense over the remaining vesting period, without any changes in measurement. For all new stock option awards that are granted or modified after the
effective date, the Company would use SFAS No. 123Rs measurement model, expense recognition, and settlement provisions. Based on the expected
remaining unrecognized fair value of stock option awards the Company estimated for purposes of preparing its current SFAS No. 123 pro forma disclosures
above, the effect of adopting SFAS No. 123R in 2005 on net income is expected to be approximately $0.4 million, or approximately $0.01 per
share.

3.

OUTSOURCED GOVERNMENT PORTAL CONTRACTS

Each of the Companys outsourced government
portal contracts generally has an initial term of three to five years with provisions for renewals for various periods at the option of the government.
The Companys primary business obligation under these contracts is to design, build and operate Internet-based portals on behalf of governments
desiring to provide access to government information and to complete government-based transactions online. NIC typically markets the services and
solicits users to complete government-based transactions and to enter into subscriber contracts permitting the user to access the portal and the
government information contained therein in exchange for transactional and/or subscription user fees. The Company is typically responsible for funding
up front investment and ongoing operational costs of the government portals. The Company enters into separate agreements with various agencies and
divisions of the government to provide specific services and to conduct specific transactions. These agreements preliminarily establish the pricing of
the electronic transactions and data access services the Company provides and the division of revenues between the Company and the government agency.
The government must approve prices and revenue sharing agreements. The Company generally owns all the applications developed under these contracts.
After completion of a defined contract term, the government agency typically receives a perpetual, royalty-free license to the applications for use
only. If the Companys contract were not renewed after a defined term, the government agency would be entitled to take over the portal in place
with no future obligation of the Company. In a few instances, the Company has entered into contracts to provide portal consulting, development and
management services to governments in exchange for an agreed-upon fee. Under a typical portal contract, the Company is required to fully indemnify its
government clients against claims that the

55

Companys services infringe upon the
intellectual property rights of others and against claims arising from the Companys performance or the performance of the Companys
subcontractors under the contract. The Company has never experienced such claims.

The following is a summary of the Companys
sixteen outsourced state government portal contracts that are primarily funded with transaction fees paid by users at December 31,
2004:

NIC Subsidiary

Portal Name (Government Entity)

Year
Services
Commenced

Contract Expiration Date
(Renewal Option Through)

Kentucky
Interactive

www.Kentucky.gov (Kentucky)

2003

4/30/2005
(1/30/2013)

Alabama
Interactive

www.Alabama.gov (Alabama)

2002

1/7/2005
(Contract has
been indefinitely extended
to allow the state time to
provision future portal
services)

As further discussed in Note 1, from September 1999
through October 2000, NIC acquired four companies and formed one business alliance that have comprised the majority of the Companys software
& services businesses. Throughout this period of rapid expansion, the Company incurred substantial net losses primarily as a result of these
businesses. Over the past four years, these businesses have undergone substantial organizational restructurings and consolidations resulting in
impairment losses and restructuring charges. In the second quarter of 2002, the Company recorded impairment losses totaling $4.3 million relating to
its AOL and IDT businesses. As part of a broad strategic refocusing of the Company on its profitable core outsourced portal business during 2002, NIC
exited its eProcurement business, decided to wind down its transportation business and restructured the other software & services businesses in an
effort to accelerate the Companys path to profitability. Management has refocused these businesses on operations it believes have demonstrable
ability to produce positive net income and cash flow in the future. However, any projections of future results of operations and cash flows are subject
to substantial uncertainty. The following is a discussion of certain of those businesses, including those for which the Company recorded impairment
losses and classified as discontinued operations in 2002.

NIC Commerce

In the second quarter of 2002, the Houston-Galveston
Area Council (HGAC) informed NIC Commerce that HGAC was terminating its eProcurement contract with Bank of America and NIC Commerce
effective May 31, 2002. HGAC cited low usage of the system as the primary reason for terminating the contract, as historical procurement volumes did
not meet minimum requirements to keep the system operational. As a result of the HGAC

56

contract termination, and as part of a broader
strategic refocusing of the Company on its profitable core outsourced portal business, NIC decided to shut down its eProcurement business. In June
2002, NIC Commerce reached an agreement to terminate its remaining eProcurement contract with the State of South Carolina. As a result of the decision
to shut down its eProcurement business, the Company determined that certain hardware, software and other fixed assets at NIC Commerce would no longer
be useful and recorded a loss of approximately $1.4 million in the second quarter of 2002 for the amount by which the carrying value of the fixed
assets exceeded their estimated fair values upon disposal. As of June 30, 2002, the Company had exited its domestic eProcurement business
entirely.

The results of operations of NIC Commerce have been
classified as discontinued operations, and information presented for all periods reflects this classification. NIC Commerces operations were
previously reported in the eProcurement segment. There were no components of amounts reflected in the Companys consolidated balance sheets or
statements of operations as of and for the years ended December 31, 2003 and 2004 related to discontinued operations. Components of amounts reflected
in the Companys consolidated statement of operations for the year ended December 31, 2002 related to discontinued operations are presented in the
following table:

Year ended
December 31, 2002

Statement of
operations data:

Revenues

$

221,863

Costs and
expenses

1,747,690

Loss on disposal
of property and equipment

1,425,153

Depreciation and
amortization

390,881

Operating
loss

(3,341,861

)

Income tax
benefit

(1,306,398

)

Loss from
discontinued operations

$

(2,035,463

)

Intelligent Decision Technologies  IDT

During the second quarter of 2002, the Company
identified indicators of possible impairment of goodwill related to the IDT acquisition. The impairment indicators included, but were not limited to,
the recent underperformance of this business relative to plan, the expected underperformance of this business as compared to projected future operating
results, and NICs recent strategic refocusing on the Companys core portal outsourcing business. Specifically, NIC determined that the
recent downturn in IDTs financial performance was expected to continue and would not be temporary, as the Company previously expected. This was a
reversal of IDTs historical trend of profitability, and was primarily attributable to government-imposed contract delays and funding shortfalls
on the part of governments with whom IDT had contracted. Management reached the conclusion that it would not continue to support IDTs business
and decided to wind down IDTs operations. Accordingly, the Company concluded the remaining goodwill related to the IDT acquisition no longer had
value and recognized a $1.3 million impairment loss in the second quarter of 2002.

In the fourth quarter of 2002, the Company reached a
settlement with the former IDT shareholders to resolve any possible contingent liabilities NIC might have related to the shutdown of IDT prior to three
years from the date of the acquisition. Under the terms of the Agreement and Plan of Merger dated September 8, 2000, an additional 208,333 to 520,826
shares of NIC common stock were to be issued contingent upon IDTs meeting certain financial performance levels over three years. The Company
negotiated a settlement to issue 140,000 shares of NIC common stock to the former IDT shareholders, which was less than the minimum incentive amount,
because IDT was only allowed about half of the contracted time period to attempt to reach the minimum incentive level. The fair value of the common
stock issued was $197,400 and was expensed in 2002. Fair value of the common stock was determined based on the closing market price of NICs
common stock on December 31, 2002, the effective date of the settlement.

57

At December 31, 2004, the IDT business did not
qualify as a discontinued operation. The Company may incur costs in future periods to exit this business. However, the Company does not currently
believe these costs will have a material adverse affect on the Companys financial condition, results of operations or liquidity.

AOL

On August 25, 2000, NIC entered into a three-year
Interactive Services Agreement (the Agreement) with America Online, Inc. (AOL) to deliver government information, services and
applications through AOLs Government Guide. Under the terms of the Agreement, NIC received advertising revenues as the exclusive provider of
AOLs Government Guide content. AOL and NIC shared revenues generated from the license or sale of advertisement by AOL on or through the
Government Guide. In return for this exclusive right, NIC paid to AOL carriage payments in the form of cash and fully vested warrants to purchase NIC
common stock, as further discussed below. NIC also provided AOL content that improved the quality of government guide, and granted to AOL a
royalty-free, non-exclusive, worldwide license to use the content and applications developed by NIC (the Customized Programming and Licensed
Content). In addition, NIC funded the initial investment and ongoing operational costs to develop, operate and maintain the Customized
Programming and Licensed Content.

NIC was to pay a $4.5 million cash carriage fee to
AOL over the initial three-year term of the Agreement. In January 2002, NIC entered into an amendment to the Agreement (the Amendment).
Among other changes to the Agreement, the Amendment extended the original three-year term of the Agreement to 40 months (ending on December 25, 2003),
eliminated AOLs right to extend the Agreement beyond the 40-month term, reduced the cash carriage fee by $1.8 million (from $4.5 million to $2.7
million) and eliminated AOLs right to receive contingent warrants in NIC common stock if gross advertising revenues collected during the period
the Agreement was in effect met or exceeded certain levels.

As an additional component of the carriage fee in
the initial Agreement, NIC issued to AOL fully vested common stock warrants representing the right to immediately purchase 624,653 shares of NIC common
stock at an exercise price of $6.71875 per share. The exercise price per share was calculated based on the average closing price of NIC common stock
for the four trading days prior to the August 28, 2000 announcement date of the Agreement. The warrants expire five years from the date of the
Agreement, and include both physical and net share settlement alternatives, which are controlled by AOL. The maximum number of shares to net settle the
warrants could never be greater than the number of warrants issued to AOL. The warrants do not include a cash settlement alternative.

In Issue 96-18, Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, the EITF reached a
consensus that the measurement date for an award that is nonforfeitable and that vests and is exercisable immediately could be the date the parties
enter into a contract, even though the services have not yet been performed. Accordingly, the Company determined that the proper accounting treatment
for the warrant portion of the carriage fee was to account for the fair value cost of the warrants at the date of the Agreement. The fair value of the
warrants issued to AOL was determined to be approximately $4.75 million on August 25, 2000, using the Black-Scholes option-pricing model. The EITF
reached a consensus in Issue 00-18, Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than
Employees, that an asset acquired in exchange for the issuance of fully vested, nonforfeitable equity instruments should not be presented or
classified as an offset to equity on the grantors balance sheet once the equity granted is issued for accounting purposes. Accordingly, NIC
recorded the fair value of the fully vested warrants as an intangible asset and permanent equity in its consolidated balance sheets.

Through the second quarter of 2002, NIC recognized
the fair value of the fully vested warrants on a straight-line basis over the term as amortization expense and recognized the cash portion of the
carriage fee on a straight-line basis over the term as cost of software & services revenues in the consolidated statement of
operations.

During the second quarter of 2002, the Company
identified indicators of impairment of the cash and warrant portions of the carriage fee paid and payable to AOL. Beginning in the second quarter of
2001, NICs share of revenues generated from AOLs sale of advertisement through Government Guide had increased steadily on
a

58

sequential quarterly basis. However, in the
second quarter of 2002, revenues from the Companys AOL business decreased precipitously as compared to recent quarters. This was primarily a
result of lower AOL Government Guide advertising revenues due to weakness in the overall advertising market in general and the online advertising
market in particular. This drop in advertising revenues was in contrast to the growth in revenues the Companys AOL business had experienced
historically. Additionally, based on discussions with AOL personnel at the time, the Company did not expect its AOL business to achieve revenue growth
consistent with the growth it had experienced historically. AOL had specifically noted in their filings with the SEC at the time that they expected the
weakness in the online advertising market to continue for the foreseeable future. Accordingly, the Company reduced the revenue forecast for its AOL
business for the remainder of 2002 and through the completion of its contract with AOL.

Management determined that the expected future cash
flows of its AOL business would not be sufficient to recover the cash carriage fee the Company would have recognized over the remaining term of the
contract with AOL. Through the second quarter of 2002, the Company had made cash payments to AOL totaling approximately $2.3 million, with
approximately $500,000 recorded as a prepaid expense at June 30, 2002, and had to pay the remaining $412,500 in a series of three quarterly
installments ending in March 2003. Additionally, management determined the future cash flows of this business would not be sufficient to recover the
unamortized carrying amount of the fully vested warrants issued to AOL, which totaled approximately $2.1 million at June 30, 2002. As discussed above,
the carrying amount of the fully vested warrants was previously recorded as an intangible asset in the Companys consolidated balance sheet. As a
result, the Company recognized a $3.0 million impairment loss in the second quarter of 2002.

In June 2003, NIC entered into a second amendment to
the Agreement (the Second Amendment). Among other changes to the Agreement and Amendment, the Second Amendment extended the term of the
Agreement from 40 months to 52 months (ending on December 31, 2004), reduced the cash carriage fee by $137,500 (from $2,700,000 to $2,562,500) and
provided NIC the right to terminate the Agreement if quarterly advertising revenues did not reach $27,000 (the Quarterly Minimum Revenue Share
Target) for any calendar quarter after April 1, 2003. The Quarterly Minimum Revenue Target increased to $33,000 in 2004. In the event of a
shortfall of the Quarterly Minimum Revenue Share Target, AOL could elect to pay NIC the difference between the actual quarterly revenue amount and the
Quarterly Minimum Revenue Share Target (the Shortfall Payment). If AOL were to make a Shortfall Payment, NICs notice of termination
would be deemed withdrawn.

As of June 30, 2003, NIC had made all cash carriage
fee payments due to AOL. During the second quarter of 2003, the Company reversed $137,500 of carriage fee expense in cost of software and services
revenues, since this amount was no longer owed to AOL as a result of the Second Amendment. This amount was previously accrued as payable to AOL when
the Company recorded the $3.0 million impairment loss in the second quarter of 2002.

The Companys contract with AOL expired on
December 31, 2004, and was not renewed.

NIC Conquest

In January 2000, NIC merged its application services
division with Conquest, acquiring a 65% ownership in the new company, which was renamed NIC Conquest. The merger was accounted for as a purchase. In
May 2000, NIC acquired an additional 6.5% ownership interest in NIC Conquest from NIC Conquests chief executive officer in exchange for 158,941
unregistered shares of NIC common stock, giving NIC ownership of 71.5% of NIC Conquest. The NIC shares that were issued to NIC Conquests chief
executive officer on May 1, 2000 were delivered to an escrow account and were to be released in equal annual installments over a three-year period,
beginning one year from the date of the exchange agreement. The first annual installment was released in May 2001. However, the remaining two
installments totaling 105,961 shares were forfeited in 2002 pursuant to certain provisions contained in the May 1, 2000 exchange agreement. The Company
retired these forfeited shares in the second quarter of 2002. No value was associated with the retirement of these shares as the related goodwill that
the Company recorded upon the issuance of the shares was impaired in the fourth quarter of 2001.

At any time after January 12, 2002, NIC had the
right to purchase all, but not less than all, of the non-NIC shareholders shares for 12 times NIC Conquests immediately preceding 12
months EBITDA divided by 30

59

million, which is the number of outstanding
Conquest shares. On March 1, 2002 (the Call Date), NIC exercised its call rights to purchase all of the non-NIC shareholders shares.
Since NIC Conquest experienced negative EBITDA in calendar 2001, the purchase price of the shares was $0. In accordance with the terms of the
Investors Rights Agreement (the Rights Agreement) dated January 12, 2000, the closing of this transaction occurred on April 8, 2002.
NIC granted the non-NIC shareholders certain residual rights in the Rights Agreement if NIC Conquest experiences a change in control within 48 months
after the Call Date. If a change of control of NIC Conquest occurs within 12 months after the Call Date, the non-NIC shareholders would receive 35% of
the difference between the price NIC paid the non-NIC shareholders and the price NIC received for NIC Conquest in a public offering, merger or
acquisition. The non-NIC shareholders would receive approximately 26% of the difference in price if the event occurs within 24 months of the Call Date,
18% within 36 months of the Call Date and 9% within 48 months of the Call Date.

At December 31, 2004, NIC Conquest was primarily
engaged in servicing the contract with the California Secretary of State. This business is not actively marketing its applications and services to new
government entities.

5.

PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at
December 31:

2003

2004

Furniture and
fixtures

$

1,580,789

$

1,278,091

Equipment

7,232,505

8,186,499

Purchased
software

1,688,843

1,887,284

Leasehold
improvements

208,069

218,971

10,710,206

11,570,845

Less
accumulated depreciation

7,718,610

8,968,141

$

2,991,596

$

2,602,704

Depreciation expense for the years ended December
31, 2002, 2003 and 2004, was $2,519,205, $1,640,638 and $1,438,253 respectively.

6.

INVESTMENTS IN AFFILIATES AND JOINT VENTURES

In March 2000, NIC completed a $5 million cash
investment in E-Filing.com, Inc. (E-Filing), a provider of online filing applications for legal services, giving NIC ownership of 21% of
E-Filing, a non-pubic company, through 2,433,800 shares of Series A voting Preferred Stock. The investment has been accounted for under the equity
method. In May 2004, E-Filing repurchased the Companys ownership interest in E-Filing for $535,000, which approximated the carrying value of the
Companys investment at the date of the repurchase. The Company received approximately $300,000 in cash and a $235,000 subordinated promissory
note with principal plus 5% interest payable annually in three equal installments on each of the first, second and third anniversary dates of the
issuance of the note. The Company had no investment balance remaining in E-Filing after the repurchase.

In March 2000, NIC completed a $5.5 million cash
investment in Tidemark Computer Systems, Inc., which was subsequently renamed Tidemark Solutions, Inc. (Tidemark), a provider of online
permit applications for local government, giving NIC ownership of approximately 27% of Tidemark, a non-public company, through 4,530,396 shares of
Series B voting Preferred Stock. The investment was accounted for under the equity method. In May 2001, a private technology company acquired Tidemark
for cash consideration of approximately $1.6 million. NIC received approximately $700,000 in cash from the transaction and had no investment balance
remaining after the acquisition. NIC realized a gain of approximately $300,000 from the transaction, which the Company deferred until the end of the
two-year indemnification period following the closing of the acquisition that covered the selling shareholders representations and warranties
made in the acquisition agreement. The Company recognized this gain in May 2003, which is included in Equity in net loss of affiliates in the
consolidated statement of operations for the year ended December 31, 2003.

60

In October 2000, NIC made an initial $524,000 cash
investment in e-Government Solutions Limited (eGS), a private joint venture among Swiss venture capital firm ETF Group, London-based
venture development organization Vesta Group, and NIC European Business Limited (NIC Europe), a European subsidiary of NIC, giving NIC
initial ownership of 40% of the ordinary shares of eGS. The purpose of the eGS joint venture, based in London, England, was to deliver eGovernment
services throughout Western Europe, with initial efforts to focus on the United Kingdom. In September 2001, the joint venture agreement was modified
and reduced NICs obligation to make future cash contributions to the joint venture and gave NIC ownership of 47% of the ordinary shares of eGS.
In December 2002, the joint venture agreement was again modified and, among other changes, eliminated NICs obligation to make future cash
contributions to the joint venture, reduced NICs ownership in the joint venture to 20% and eliminated NICs participation on the board of
directors of the joint venture. The investment had been accounted for under the equity method. As a result of the modification to the joint venture
agreement in December 2002, the Company began to account for its investment in eGS under the cost method beginning in fiscal 2003. Through December 31,
2002, NICs cash contributions to eGS totaled approximately $1.0 million. At December 31, 2002, NIC had no investment balance remaining in eGS. At
December 31, 2004, the Companys ownership interest in eGS was approximately 14%.

7.

DEBT OBLIGATIONS AND COLLATERAL REQUIREMENTS

The Company issues letters of credit as collateral
for performance on certain of its outsourced government portal contracts and as collateral for certain performance bonds. These irrevocable letters of
credit are generally in force for one year, for which the Company pays bank fees of approximately 1.5% to 2.0% of face value per annum. In total, the
Company and its subsidiaries had unused outstanding letters of credit of approximately $6.4 million at December 31, 2003 and 2004. The Company is
currently required to collateralize certain letters of credit with its cash and cash equivalents. During the third quarter of 2004, the Companys
cash collateral requirements pertaining to letters of credit under its current banking agreement were reduced from $5 million to $3
million.

In conjunction with its business filings contract
with the California Secretary of State, in March 2002, the Company issued a $5 million letter of credit as collateral for a $5 million performance bond
required by the contract. In 2004, the Company received milestone payments totaling approximately $6.6 million for the delivery of the UCC filing
system into production and acceptance testing. Of the $6.6 million in milestone payments received, approximately $0.6 million related to work that had
not been fully completed at December 31, 2004. The Company is scheduled to receive two additional milestone payments of approximately $3.3 million in
the future, currently estimated to be over the course of the next 12 to 15 months. The first payment will be for the delivery of the business entity
filing system into acceptance testing. The second payment will be for the acceptance of the business entity filing system by the Secretary of State and
commencement of the associated maintenance period. Upon acceptance of the business entity filing system and commencement of the associated maintenance
period, the Company will no longer be required to provide a performance bond under this contract.

In August 2001, the Company borrowed $1.0 million
from a bank in the form of a promissory note payable to finance the purchase of certain hardware and software components for its eProcurement business.
At December 31, 2003, the note payable had a balance of approximately $363,000 and was fully collateralized by cash and cash equivalents. In July 2004,
the Company paid off the note in full and had no balance remaining at December 31, 2004.

The Company has a $500,000 working capital line of
credit, which was unused at December 31, 2003 and 2004.

At December 31, 2003 and 2004, the Company had
pledged a total of approximately $5.4 million and $3.0 million, respectively, of its cash and cash equivalents as collateral under the financing
arrangement that covers all of the Companys outstanding letters of credit, term note payable and working capital line of credit, and has given
the bank a security interest in certain of its accounts receivable and other assets. At December 31, 2003 and 2004, the Company classified $5.4 million
and $3.0 million, respectively, of its cash and cash equivalents as restricted in its consolidated balance sheets.

61

The Company has a $500,000 line of credit with a
separate bank in conjunction with a corporate credit card agreement. At December 31, 2003, NIC had pledged all of its marketable securities as
collateral on the line of credit. At December 31, 2004, the Company is no longer required to collateralize the line of credit.

8.

COMMITMENTS AND CONTINGENCIES

Operating leases

The Company and its subsidiaries lease office space
and certain equipment under noncancellable operating leases. Future minimum lease payments under all noncancellable operating leases at December 31,
2004 are as follows:

Fiscal Year

2005

$

1,304,993

2006

827,952

2007

474,091

2008

153,275

2009

1,055

Thereafter



Rent expense for operating leases for the years
ended December 31, 2002, 2003 and 2004 was approximately $1,612,000, $1,603,000 and $1,491,000, respectively.

Litigation

The Company is involved from time to time in legal
proceedings and litigation arising in the ordinary course of business. However, the Company is not currently involved with any legal
proceedings.

9.

SHAREHOLDERS EQUITY

Common stock

On June 30, 1998, the Company and the National
Information Consortium Voting Trust (the Voting Trust) consisting of all the Companys then current shareholders entered into a stock
purchase agreement for the Companys shareholders to sell a 25% interest in the Company to an investment management firm. The Company did not
receive any of the proceeds from the sale. Under the Voting Trust agreement, two principal shareholders have the right to vote all of the Voting
Trusts common shares and to sell all or any part of such shares. In 2003, the Voting Trust distributed 5% of its shares of NIC common stock to
its members. At December 31, 2003 and 2004, the Voting Trust held approximately 26.1 million shares of NIC common stock. On January 28, 2005, the
Voting Trust distributed 10% of its shares of NIC common stock to its members. After the distribution, the Voting Trust held approximately 23.5 million
shares of NIC common stock.

Common stock transactions

On July 20, 1999, the Company completed its initial
public offering of common stock by selling an aggregate of 10 million new shares of common stock for net proceeds of approximately $109.4 million after
deducting underwriting discounts, commissions and expenses.

As a condition of separation and severance from the
Company in the second quarter of 2002, a former executive had the right to request the Company to repurchase all of the shares of the Companys
common stock, totaling 149,488 shares, beneficially owned by the former executive that were held of record in the Voting Trust for $1.44 per share. In
October 2002, the former executive exercised this right and caused the Company to repurchase his Voting Trust units for $215,260. The shares of NIC
common stock represented by the Voting Trust Units have been recorded as treasury stock in the consolidated balance sheets. In 2003, the Voting Trust
distributed 5% of its shares

62

of NIC common stock to its members. This
affected 7,474 shares of NIC common stock held by the Company as treasury stock. The Company retired these shares in 2003, which had an assigned value
of $10,763. At December 31, 2004, the Company had 142,014 shares remaining in treasury stock. In January 2005, the Voting Trust distributed 10% of its
shares of NIC common stock to its members. This affected 14,201 shares of NIC common stock held by the Company as treasury stock. The Company retired
these shares in February 2005, which had an assigned value of $20,449, and has 127,813 shares remaining in treasury stock.

Additional paid-in capital

During 2002, certain employees of the Company had
disqualifying dispositions of common stock obtained through the exercise of incentive stock options. As a result, the Company received a federal income
tax deduction of approximately $536,000 in 2002. For the year ended December 31, 2002, the Company had recognized compensation expense of approximately
$217,000 for the excess of fair value of the Companys common stock on the grant date over the exercise price for options granted to certain of
these employees. A portion of the tax benefit relating to the disqualifying dispositions totaling $217,000 has been recognized in the Companys
results of operations, and the remaining tax benefit for the excess deduction was credited directly to additional paid-in capital. Also during 2002,
certain current and former employees of the Company exercised non-qualified stock options. As a result, the Company received a federal income tax
deduction of approximately $475,000 in 2002. For the year ended December 31, 2002, the Company had recognized compensation expense of approximately
$292,000 for the excess of fair value of the Companys common stock on the grant date over the exercise price for options granted to certain of
these employees. A portion of the tax benefit relating to the exercises totaling $292,000 has been recognized in the Companys results of
operations, and the remaining tax benefit for the excess deduction was credited directly to additional paid-in capital.

At December 31, 2002, the Company had recognized a
deferred tax asset of approximately $1.5 million for the cumulative stock compensation expense recognized to date related to non-qualified stock
options granted to certain employees with the fair value of the Companys common stock on the grant date greater than the exercise price for
options granted. Through December 31, 2002, the actual tax deductions resulting from exercises of these non-qualified stock options were less than the
cumulative amount of stock compensation expense recognized in the Companys results of operations. The write off of the related deferred tax asset
in excess of the benefits of the actual tax deductions was debited directly to additional paid-in capital for $1,341,992, which was the amount of
excess tax deductions credited to additional paid in capital in prior years from previous stock option grants. The remainder of the write off was
recognized as income tax expense in the consolidated statement of operations. See Note 10.

During 2003 and 2004, certain employees of the
Company exercised non-qualified stock options. As a result, the Company received federal income tax deductions. The tax benefit for the deductions of
$546,623 for 2003 and $688,604 for 2004 were credited directly to additional paid-in capital.

Business acquisitions and other transactions

For additional information relating to business
acquisitions and other transactions involving the issuance of common stock or warrants, refer to Note 4.

63

10.

INCOME TAXES

The provision (benefit) for income taxes from
continuing operations consists of the following:

Year Ended December 31,

2002

2003

2004

Current
income taxes:

Federal

$



$



$

238,731

State

206,160

332,735

135,285

Total

206,160

332,735

374,016

Deferred
income taxes:

Federal

(3,210,702

)

596,104

3,650,706

State

(527,498

)

256,314

680,179

Total

(3,738,200

)

852,418

4,330,885

Total income
tax provision (benefit)
from continuing operations

$

(3,532,040

)

$

1,185,153

$

4,704,901

Significant components of the Companys
deferred tax assets and liabilities were as follows at December 31:

2003

2004

Deferred tax
assets:

Net operating
loss carryforward

$

25,647,102

$

21,538,469

Amortization
and impairment of purchase accounting goodwill
and software intangibles

9,526,987

8,641,536

Capital loss
on sale of affiliate

1,927,748

3,792,358

Investments
in affiliates

2,364,802

548,780

Accrued
contract expenses under percentage of
completion accounting



1,462,734

Application
development contract losses

180,748



Other

159,448

335,574

39,806,835

36,319,451

Less:
Valuation allowance

(4,292,550

)

(4,341,138

)

Total

35,514,285

31,978,313

Deferred tax
liabilities:

Depreciation

(144,799

)

(271,071

)

Capitalized
software development costs

(19,963

)



Total

(164,762

)

(271,071

)

Net deferred
tax asset

$

35,349,523

$

31,707,242

For federal income tax purposes, the Company had
available at December 31, 2004, total net operating loss (NOL) carryforwards of approximately $59.4 million that will expire in 2020 ($22.0
million), 2021 ($27.1 million) and 2022 ($10.3 million). The Company believes it is more likely than not it will generate sufficient taxable income
from future operations to fully utilize the NOL carryforwards prior to expiration. The amount of the deferred tax asset considered realizable relating
to these NOLs could be reduced in the near term if estimates of future taxable income during the carryforward periods are
reduced.

Prior to April 8, 2002, the Companys ownership
in NIC Conquest was less than 80% (see Note 4). As a result, NIC Conquest was not included in the Companys consolidated federal income tax return
prior to this time. Due to developments arising in the second half of 2001 relating to NIC Conquests migration to a common operating platform for
its core UCC and corporations filing applications, the Company determined that the balance of revenues remaining to be recognized under existing
application development contractual obligations was not expected to

64

cover anticipated costs of developing and
implementing the related applications and accrued losses of approximately $6.0 million in the third and fourth quarters of 2001. These losses coupled
with the significant underperformance of this business and uncertainty regarding future performance of this business cast substantial doubt as to
whether NIC Conquests NOL carryforwards and other deferred tax assets could be used in the future. Consequently, in the fourth quarter of 2001,
the Company provided a deferred tax asset valuation allowance of $5,284,576 for the net deferred tax asset relating to NIC Conquest. The Company
acquired 100% ownership of NIC Conquest on April 8, 2002. As a result of the change in ownership, the Company released the portion of the valuation
allowance that was not related to NIC Conquests tax NOL carryforwards generated through the date of the change in ownership. The NIC Conquest
deferred tax asset valuation allowance was $3,214,026 at December 31, 2002.

In the fourth quarter of 2003, the Company completed
an internal reorganization and legal entity restructuring plan to simplify NICs corporate structure, standardize business development and
contracting practices, increase internal operating efficiencies through reduced administrative costs, and concentrate all companies under one
subsidiary, NICUSA. As of December 31, 2003, most operating subsidiaries had been or were in the process of being converted to single member limited
liability companies (LLCs) directly owned by NICUSA. Management believes the restructuring will be treated as tax-free reorganizations or liquidations.
As a result of the restructuring, certain NOL carryforwards relating to the Companys NIC Conquest business that were generated prior to the date
the Company acquired 100% ownership of NIC Conquest can now be utilized by NICUSA. Consequently, in the fourth quarter of 2003, the Company released
the deferred tax asset valuation allowance relating to NIC Conquest totaling $3,214,026.

In the fourth quarter of 2003, management identified
certain deferred tax assets pertaining to section 197 intangible asset amortization that the Company had not recognized since the acquisition of NIC
Conquest in January 2000. The Company believes that it is more likely than not that it will be able to utilize this deferred tax asset in the future.
Accordingly, in the fourth quarter of 2003, the Company recognized an additional deferred tax asset totaling $1,483,386. The Company also identified
certain estimated state NOL carryforwards that it had previously recognized that it may be unable to use. Based on a review of applicable state tax
statutes, the Company concluded that there is substantial doubt it would be able to realize the full amount of certain estimated NOL carryforwards in
states where the Company cannot file a consolidated income tax return. As a result, in the fourth quarter of 2003, the Company reduced its net deferred
tax asset by $483,386.

In 2000, the Company recorded a deferred tax asset
valuation allowance of $1,959,447 to offset the deferred tax asset the Company had recognized relating to its investment in Tidemark (see Note 6). In
the second quarter of 2001, the Company sold its interest in Tidemark realizing a capital loss, which can only be offset against capital gains for
federal income tax purposes. At present, there is doubt about the Companys ability to generate capital gains in the future. In 2001, the Company
adjusted the deferred tax asset valuation allowance relating to Tidemark to $1,796,675. NIC realized a book gain of approximately $300,000 from the
Tidemark sale, which the Company deferred until the end of the two-year indemnification period following the closing of the acquisition that covered
the selling shareholders representations and warranties made in the acquisition agreement. The Company recognized this gain in May 2003 and
adjusted the deferred tax valuation allowance relating to Tidemark to $1,927,748.

In the fourth quarter of 2003, the Company recorded
a deferred tax asset valuation allowance of $1,816,022 to offset the deferred tax asset applicable to the excess of the Companys tax over book
basis of its investment in E-Filing. E-Filings business had not developed as fast as the Company had expected, and the Company believed that the
most likely outcome was that the investment would eventually be sold. A sale at the carrying value would produce a capital loss, and at present, there
is doubt about the Companys ability to generate capital gains in the future. In the second quarter of 2004, the Company sold its interest in
E-Filing, realizing a capital loss, and adjusted the deferred tax allowance relating to E-Filing to $1,864,610. See note 6.

In the fourth quarter of 2003, the Company recorded
a deferred tax asset valuation allowance of $548,780 to offset the deferred tax asset the Company had recognized relating to its investment in eGS (see
Note 6). eGS had incurred significant historical operating losses and the business had not developed as fast as the Company had

65

expected. The Company currently believes that
the most likely outcome is that the investment will eventually be sold. A sale at the carrying value would produce a capital loss, and at present,
there is doubt about the Companys ability to generate capital gains in the future.

In 2002, the Company recorded a deferred tax asset
adjustment of approximately $1.5 million for compensation related to non-qualified stock options, which reduced additional paid-in capital (see Note
9).

In October 2004, the American Jobs Creation Act of
2004 was enacted into law. The new law contains provisions that could impact the Company. These provisions provide for, among other things, a special
deduction from U.S. taxable income equal to a stipulated percentage of qualified income from domestic production activities (as defined) beginning in
2005. This provision is complex and subject to numerous limitations. The Company is still studying the new law, including the technical provisions
related to the complex provision noted above. The effect on the Company of the new law, if any, has not yet been determined, in part because the
Company has not definitively determined whether its operations qualify for the special deduction. If the Company determines it qualifies for the
special deduction, the tax benefit of such special deduction would be recognized in the period earned.

The following table reconciles the effective income
tax rate from continuing operations indicated by the consolidated statements of operations and the statutory federal income tax rate:

Year Ended December 31,

2002

2003

2004

Effective
federal and state income tax rate

38.8

%

15.8

%

39.8

%

Adjustment
related to NIC Conquest



22.1



Reduction of
state NOL carryforwards



(5.8

)



Impairment of
intangible assets

4.8





Non-deductible stock compensation expense

1.1





State income
taxes

(1.4

)

(5.1

)

(4.5

)

Valuation
allowance

(9.1

)

9.4

(0.4

)

Other

0.8

(1.4

)

0.1

Statutory
federal income tax rate

35.0

%

35.0

%

35.0

%

11.

EMPLOYEE BENEFIT AND STOCK OPTION PLANS

Defined Contribution 401(k) Profit Sharing Plan

The Company and its subsidiaries sponsor a defined
contribution 401(k) profit sharing plan. In accordance with the plan, all full-time employees are eligible immediately upon employment. A discretionary
match of up to 5% of an employees salary and a discretionary contribution may be made to the plan as determined by the Board of Directors.
Expense related to Company matching contributions totaled approximately $276,000, $207,000 and $222,000 for the years ended December 31, 2002, 2003 and
2004, respectively.

Employee Stock Purchase Plan

In May 1999, the Companys Board of Directors
approved an employee stock purchase plan intended to qualify as an employee stock purchase plan under Section 423 of the Internal Revenue
Code. A total of 2,321,688 shares of NIC common stock have been reserved for issuance under this plan. Terms of the plan permit eligible employees to
purchase NIC common stock through payroll deductions up to 15% of each employees compensation. Amounts deducted and accumulated by the
participant will be used to purchase shares of NICs common stock at 85% of the lower of the fair value of the common stock at the beginning or
the end of the offering period, as defined. The first offering period under this plan commenced on April 1, 2001 and ended on March 31, 2002, with
32,504 shares being purchased. The second offering period commenced on April 1, 2002 and ended on March 31, 2003, with 48,731 shares being purchased.
The third offering period commenced on April 1, 2003 and ended on March 31, 2004, with 80,325 being purchased. The fourth offering period commenced on
April 1, 2004. The closing fair market

66

value of NIC common stock on the first day of
the fourth offering period was $6.00 per share. Approximately 22,000 shares of NIC common stock are expected to be purchased in the fourth offering
period.

Stock Option Plans

The Company has two formal stock option plans (the
NIC plan and the SDR plan) to provide for the granting of either incentive stock options or non-qualified stock options to
encourage certain employees of the Company and its subsidiaries, and certain directors of the Company, to participate in the ownership of the Company,
and to provide additional incentive for such employees and directors to promote the success of its business through sharing the future growth of such
business. The NIC plan was adopted in May 1998 and amended in November 1998, May 1999 and May 2004. Under the NIC plan, the Company is authorized to
grant options for up to 9,286,754 common shares. Employee options are generally exercisable one year from date of grant in cumulative annual
installments of 25% to 33% and expire four to five years after the grant date. At December 31, 2004, a total of 1,261,825 options were available for
future grants under the NIC plan. The SDR plan was adopted in May 2000 in conjunction with NICs acquisition of SDR. Under the SDR plan, the
Company is authorized to grant options for up to 229,965 common shares. No options that are in addition to those granted upon the close of the SDR
acquisition will be granted under the SDR plan. There have been no option repricings under the plans.

A summary of the activity under the Companys
stock option plans for the years ended December 31, 2002, 2003 and 2004 is presented below:

2002

2003

2004

Shares

Weighted
Average
Exercise Price

Shares

Weighted
Average
Exercise Price

Shares

Weighted
Average
Exercise Price

Outstanding
at January 1

7,663,866

$

5.36

4,758,470

$

5.95

4,566,539

$

3.98

Granted

1,345,450

$

1.81

1,880,243

$

3.45

540,750

$

5.07

Exercised

(1,915,094

)

$

1.51

(574,595

)

$

2.02

(505,378

)

$

2.35

Expired

(1,221,181

)

$

6.32

(973,210

)

$

14.44

(159,806

)

$

18.52

Canceled

(1,114,571

)

$

4.08

(524,369

)

$

2.69

(163,380

)

$

3.12

Outstanding
at December 31

4,758,470

$

5.95

4,566,539

$

3.98

4,278,725

$

3.80

Exercisable
at December 31

1,626,629

$

9.92

1,395,010

$

5.52

2,163,798

$

3.76

Weighted
average grant-date fair value of options granted during the year

$

1.18

$

2.24

$

2.95

In 2002, all options were granted with exercise
prices equal to the market price of the Companys common stock on the grant date. In 2003, the Company granted 1,633,200 options with exercise
prices equal to the market price of the Companys common stock on the grant date. The weighted average exercise price of such shares was $3.45 and
the weighted average grant-date fair value was $2.29. Additionally, in 2003, the Company granted 247,043 options with exercise prices that exceeded the
market price of the Companys common stock on the grant date. The weighted average exercise price of such shares was $3.45 and the weighted
average grant-date fair value was $1.93. In 2004, all options were granted with exercise prices equal to the market price of the Companys common
stock on the grant date.

67

The following table summarizes information about
stock options outstanding under the Plan at December 31, 2004:

Options Outstanding

Options Exercisable

Range of Exercise Price

Shares
Outstanding

Weighted
Average
Remaining
Contractual
Life

Weighted
Average
Exercise
Price

Shares
Outstanding

Weighted
Average
Exercise
Price

$1.532.24

1,068,334

1.1

$

1.85

941,338

$

1.82

$2.303.40

1,471,613

3.4

$

3.03

351,681

$

3.01

$3.475.18

913,559

2.3

$

3.91

457,084

$

3.77

$5.468.19

611,200

3.6

$

6.56

199,676

$

7.02

$9.5012.57

213,719

0.4

$

10.41

213,719

$

10.41

$19.32

300

5.4

$

19.32

300

$

19.32

Including expense related to options granted prior
to January 1, 2002 with exercise prices less than the fair market value of the Companys common stock on the various grant dates, the Company
recognized a total of $1,306,569 of stock compensation expense related to common stock options for the year ended December 31, 2002. The Company
recognized no stock compensation expense related to common stock options in 2003 and 2004.

12.

RELATED PARTY TRANSACTIONS

The Company rents an aircraft on an hourly basis
from a company that is owned by two shareholders/directors of the Company at costs that the Company believes are reasonable compared to similar
services provided by third parties. One of these directors is the current Chairman and Chief Executive Officer of the Company. In 2002, 2003 and 2004,
payments made to this company totaled approximately $260,000, $565,000 and $399,000, respectively.

13.

REPORTABLE SEGMENTS AND RELATED INFORMATION

The Companys two reportable segments consist
of its Outsourced Portal businesses and Software & Services businesses. The Outsourced Portals segment includes the Companys subsidiaries
operating outsourced state and local government portals and the corporate divisions that support portal operations. The Software & Services segment
includes the Companys corporate filings business (NIC Conquest), ethics & elections filings business (NIC Technologies), commercial vehicle
compliance business (IDT) and AOL division. Each of the Companys Software & Services businesses is an operating segment and has been
aggregated to form the Software & Services reportable segment. Unallocated corporate-level expenses are reported in the reconciliation of the
segment totals to the related consolidated totals as Other Reconciling Items. There have been no significant intersegment transactions for
the periods reported. The summary of significant accounting policies applies to all segments.

The measure of profitability by which management
evaluates the performance of its segments and allocates resources to them is operating income (loss). Segment asset or other segment balance sheet
information is not presented to the Companys chief operating decision maker. Accordingly, the Company has not presented information relating to
segment assets.

In the second quarter of 2002, the results of
operations of NIC Commerce were classified as discontinued operations with information presented for all periods reflecting the new classification. For
segment reporting purposes, NIC Commerces operations were previously reported in the eProcurement segment.

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The table below reflects summarized financial
information for the Companys reportable segments for the years ended December 31: